Start with the rule the government changes.
A tax or subsidy changes the payment linked to production or purchase. A price control sets a legal maximum or minimum price. A quota limits quantity. Identify the instrument, its objective and the market before drawing a diagram: a lower legal price, lower buyer payment and larger available quantity are different outcomes.
- Government payments
- A tax is a payment to government; a subsidy is support paid by government. Per unit means for each item sold or each eligible activity, such as one lesson delivered.
- Price and quantity limits
- A price ceiling is a legal maximum price; a floor is a legal minimum. A quota caps the quantity permitted in a stated period, such as 40 meals per day.
- Objective
- A policy may aim to make purchases affordable, support sellers or reduce consumption. A lower price helps only those who can obtain the good, so price and access both matter.
Set up the market before the policy
Define the unit
P means price and Q means quantity. Use matching units and one period: dollars per bottle and bottles per day, for example.
State the starting point
Demand (D) shows how much buyers are willing and able to buy at each price; supply (S) shows how much sellers are willing and able to sell. At equilibrium these quantities match: the market clears. Draw price vertically and quantity horizontally, and hold other influences unchanged when examining the policy.
Check the aim
Affordable purchases, seller support, lower consumption and government revenue are different objectives. An outcome can advance one while compromising another.
| Instrument | What the rule changes | First question |
|---|---|---|
| Tax | Payment to government on a defined base | Per unit, percentage, or another base? |
| Subsidy | Government payment for eligible activity | Who receives it and which units qualify? |
| Ceiling | Maximum legal price | Is it below equilibrium? |
| Floor | Minimum legal price | Is it above equilibrium? |
| Quota | Maximum permitted quantity | Is it below equilibrium quantity? |
Worked example: Three plans for affordable meals
A council considers a maximum meal price of $4, a $2 payment to sellers for each meal sold, or a limit of 40 meals sold per day.
- The $4 rule is a price ceiling: it restricts the price sellers can charge.
- The $2 payment is a per-unit subsidy: sellers receive support only for units sold.
- The 40-meal rule is a quota: it restricts quantity, not the price.
- To judge affordability, check both the price paid and whether households can obtain meals.
Watch out for this
Any policy that makes a good cheaper is a subsidy.
Classify the policy by its mechanism. A price ceiling is a legal restriction even if its intended result is a lower price.
Check your understanding
A policy limits the market to 500 new licences each month, with the licence price determined by bidding. What is it?
- A price ceiling, because the government is involved.
- A quota, because the number of licences is limited.
- A subsidy, because licence holders receive permission.