Controlling Quantities Ap Econ 9/12

Warm Up The accompanying table shows hypothetical demand and supply schedules for milk per year. The US government decides that the incomes of dairy farmers should be maintained at a level that allows the traditional family dairy farm to survive. So it implements a price floor of $1 per pint by buying surplus milk until the market price is $1 per pint. Price of milk (per pint) Quantity of milk demanded (millions) Quantity of milk supplied (millions) $1.20 550 850 1.10 600 800 1.00 650 750 0.90 700 0.80 In a diagram, show the deadweight loss from the inefficiently low quantity bought and sold.

Controlling Quantities A quantity control, or quota, is an upper limit on the quantity of some good that can be bought or sold. Examples of quotas: taxi ride medallions in NYC, fishing licenses A license gives its owner the right to supply a good. ***Quality controls in the real world always set an upper (not lower) limit on quantity The demand price of a given quantity is the price at which consumers will demand that quantity. “At what price will consumers want to buy 10 million rides per year?” The supply price of a given quantity is the price at which producers will supply that quantity. “At what price will seller be willing to sell 10 million rides per year?”

Controlling Quantities A wedge is the space between the demand price and the supply price of a good Quota rent is the difference between the demand and supply price at the quota limit (earnings that accrue to the license holder from ownership of the license.)

Market for Taxi Rides (no gov intervention) Fare (per ride) S $7.00 Quantity of rides (millions per year) Demand price for 10 million rides = $5 Supply price for 10 million rides = $5 6.50 Fare 6.00 Quantity demanded Quantity supplied (per ride) 5.50 E $7.00 6 14 5.00 $ 6.50 7 13 4.50 $ 6.00 8 12 4.00 $ 5.50 9 11 3.50 $ 5.00 10 10 3.00 D $ 4.50 11 9 $ 4.00 12 8 $ 3.50 13 7 $ 3.00 14 6 6 7 8 9 10 11 12 13 14 Quantity of rides (millions per year)

Effect of a Quota Demand price for 8 million rides = $6 Fare (per ride) Quantity of rides (millions per year) Fare Quantity demanded Quantity supplied (per ride) S Demand price for 8 million rides = $6 Supply price for 8 million rides = $4 Quota rent= $2 $7.00 Deadweight loss $7.00 6 14 6.50 A $ 6.50 7 13 6.00 $ 6.00 8 12 The “wedge” 5.50 E $ 5.50 9 11 5.00 $ 5.00 10 10 4.50 $ 4.50 11 9 4.00 $ 4.00 12 8 B 3.50 $ 3.50 13 7 3.00 D $ 3.00 14 6 Quota 6 7 8 9 10 11 12 13 14 Quantity of rides (millions per year)

Costs of Quantity Controls Deadweight loss because some mutually beneficial transactions don’t occur. If there is a quota limit of 8 mil rides, then 2 million rides were missed- opportunities Incentives for illegal activities. Gypsy cabs, Uber? Lift?

Practice problem (will help with HW #5) In the absence of government restrictions, what is equilibrium price and quantity? The government places a yearly quota of 80,000 lbs of lobster harvested. What is the demand price for 80,000 lbs? What is the supply price? What is the quota rent per lb? Calculate consumer surplus and producer surplus based on your answers in #2. Price of lobster Quantity Demanded (thousands of lbs) Quantity Supplied (thousands of lbs) $22 360 20 320 18 40 280 16 60 240 14 80 200 12 100 160 10 120 8 140 6 4 180

1. Which of the following will occur if a legal price floor is placed on a good below its free-market equilibrium? (A) Surpluses will develop. (B) Shortages will develop. (C) Underground markets will develop. (D) The equilibrium price will ration the good. (E) The quantity sold will increase. 2. Which of the following statements about price controls is true? (A) A price ceiling causes a shortage if the ceiling price is above the equilibrium price. (B) A price floor causes a surplus if the price floor is set below the equilibrium price. (C) A price ceiling causes an increase in demand if the ceiling price is set below the equilibrium price. (D) A price ceiling causes a decrease in demand if the price ceiling is set above the equilibrium price. (E) Price ceilings and price floors result in a misallocation of resources. 3. Assume that the fast-food industry is perfectly competitive and employs only one factor of production: unskilled workers. Use supply and demand analysis to explain how the increase in the wage rate resulting from the imposition of the minimum wage will affect each of the following in the fast-food industry in the short run. (i) Price of fast food (ii) Quantity of fast food produced