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Effects of taxation and price control on the economy

Most economists’ perceive taxation and price controls and view them as being detrimental to the economy as a whole. The enforcement mostly results to rise in transaction costs and in same cases may lead to black markets. Regarding these circumstances, two articles have been reviewed to evaluate the effects of taxation on the demand and supply. The paper illustrates on whom is the tax is levied, effects of tax on equilibrium price and the merits and demerits of price ceilings and price floor (Ameba, 2001).

Effects of tax on supply and demand

The effects of taxation and the effects of control of price on market vary from the supply reduction of goods to costs increments. Taking an example, suppose there is a tax that is allocated on goods such as sugar or tea as the articles under review describes, the cost of the products will increase. This will result to increment in selling price of these commodities. The increment in production cost will be transferred to the consumer. Normal quantities of the product will be in the market (company will produce similar quantities as before) but at an increased price. Their demand will also decrease due to price increment. Referring to the articles, an increment of tax by 1% decreased the demand by 0.5% will the price increased by 1.25% (Belle, 2005). The increment in the cost will in turn have an effect on the supply curve. New equilibrium in the supply and demand curves will result. The equilibrium will be shifted towards left; more supply less demand. Contrary, if price controls are forced, there will be a rise in the prices if price floor, and an increase if price ceiling is imposed. The effect of price control is two sided on supply and demand. At the raised cost, lower quantity of products will be demanded as most customers will go for substitutes (Mankiw, 2008).

Whom the tax is levied In the normal cases the tax is levied on the clients. The administrative reasons that the imposed tax should be obtained from the manufacturers; this is not always the case. It is simply transferred as the manufacturers are able to pass the imposed tax to the customers. They either increase the price of the commodity by the percentage raised by tax or even higher. Whole burden is felt by consumers. The two articles illustrates what happens when a tax of $1.5 is imposed on sugar and tea produced by a company (Belle, 2005). Demand of Sugar being negatively related to its price, rise in price resulted to decrease in demand. The condition is true when the manufacturer are elastic and the consumers inelastic to price and quantity change. However, at times back shifting occurs. This is when the manufacturers are inelastic to price change. They produce the equal quantities of product despite of the price. The consumer being elastic, they are extremely sensitive to cost of selling. A slight increase in cost results to a big fall in the demanded quantity. In such cases, when the manufacturer is inelastic and consumers are elastic, the imposed tax is on the producer and they carry the load (Mankiw, 2008).

Effects of tax on the equilibrium price and quantity When tax is imposed on the commodity, its price automatically increases. Normally the consumers are inelastic and change in price lead to drop in quantity demanded. Equilibrium shifts and hence quantity demanded falls and the as price rises. Tax causes a shift on the equilibrium price and commodity (Belle, 2005).

Price control

Government at times regulates the prices of given commodities in the market. The price regulation aids to minimize the inflation rate and exploitation of the customers by the companies. They fix and impose the prices at which a given commodity or service should be sold. They do so in two ways; ‘price floor’ and ‘price ceiling’. The price ceiling is the highest cost that that a commodity should be charged. Price Floor is the lowest price that should be charged. Price ceiling is imposed when companies charge extra amounts for a given commodity. Price ceiling increase the demand of a commodity as the supply decreases. It knocks off balance of the market equilibrium (Ameba, 2001).

References

Ameba, M. (2001). Tax Policy and the Economy; National Bureau of Economic

Research. Volume 15. MIT Press Publisher.

Belle, D. (2005). Guide to taxation, public finance, and related literature. Volume 3,

Public Policy Research Publishers.

Mankiw, G. (2008). Principles of Economics; regulations of prices. Cengage

Learning Publisher.