Price Controls Floor & Ceilings

Why Governments Control Prices Buyers or sellers who are not pleased with a market’s equilibrium price may ask the government to institute price controls. Price controls are legal restrictions on how high or low a market price may go.

Why Governments Control Prices A price ceiling is a maximum price sellers are allowed to charge for a good or service. A price floor is a minimum price buyers are required to pay for a good or service.

Why Governments Control Prices What do you think the market price for renting an apartment in Plainfield is? What happens to the quantity of demand and supply if we change the price?

Price Ceilings Some housing in Manhattan is rent-controlled. The price cannot rise higher than a certain level even if renters are willing to pay for it. This is a price ceiling.

Price Ceilings Price ceilings are usually imposed when crises like wars or natural disasters cause sudden price increases that hurt consumers but enrich suppliers. When the demand for aluminum and steel skyrocketed during World War 2, the U.S. imposed price ceilings to protect buyers from paying high prices and prevent suppliers from earning enormous profits.

Quantity of apartments (millions) Monthly rent (per apartment) How Price Ceilings Cause Inefficiencies Monthly rent (per apartment) Quantity of apartments (millions) The figure on the right shows demand and supply curves and schedules for a housing market without price controls. Monthly rent (per apartment) S Quantity demanded Quantity supplied $1,400 1,300 $1,400 1.6 2.4 1,200 1,300 1.7 2.3 1,100 1,200 1.8 2.2 E 1,100 1.9 2.1 1,000 1,000 2.0 2.0 900 900 2.1 1.9 800 800 2.2 1.8 700 700 2.3 1.7 600 2.4 1.6 600 D 1.6 1.7 1.8 1.9 2.0 2.1 2.2 2.3 2.4 Quantity of apartments (millions)

How Price Ceilings Cause Inefficiencies The figure on the right shows same housing market after the institution of a price control. Because quantity demanded at point B exceeds quantity supplied at point A, there is a housing shortage.

How Price Ceilings Cause Inefficiencies Shortages: A price below equilibrium causes less of a good to be supplied than is demanded at that price. Inefficient allocation: Those willing to pay a lot don’t get the good, and those only willing to pay a little do.

How Price Ceilings Cause Inefficiencies Wasted resources: People expend money, effort, and time to cope with the shortages caused by the price ceiling. Inefficiently low quality: Sellers offer low-quality goods at a low price even if buyers prefer a higher quality at a higher price. Black markets: To avoid the price ceiling, goods are illegally sold at high prices.

So Why Are There Price Ceilings? For a few consumers, price ceilings make certain important goods more affordable than they would be in an unregulated market. An enduring price ceiling can distort people’s understanding of what would happen without it. Regulators often misunderstand how supply and demand work.

Why Governments Control Prices What do you think the market price for a worker is? What happens to the quantity of demand and supply if we change the price?

Price Floors When governments intervene in a market to push prices up, this is called a price floor. Minimum wage laws are price floors set on the hourly wage rate of workers. Like price ceilings, price floors are usually intended to help people, but create inefficiencies in a market.

Price Floors The figure on the right shows demand and supply curves and schedules for a butter market without price floors.

Price Floors The horizontal line represents the price floor. Because quantity supplied at point B exceeds quantity demanded at point A, there is a butter surplus.

How a Price Floor Causes Inefficiency Inefficiently low quantity: A price floor raises the price of a good, reducing the quantity of that good demanded. Sellers will not sell more units of a good buyers are willing to buy, reducing the quantity of a good bought and sold below equilibrium quantity. Inefficient allocation of sales among sellers: Those willing to sell a good at the lowest price are not always those who manage to sell it.

How a Price Floor Causes Inefficiency Wasted resources: The surpluses caused by price floors are often simply destroyed. When the government sets a price floor for corn, it often purchases and destroys all the corn producers cannot sell. Also, time and effort spent searching for a buyer are wasted when price floors cause a surplus. As minimum wage laws reduce employers’ demand for labor, eager laborers may spend hours searching and waiting for jobs.

How a Price Floor Causes Inefficiency Inefficiently high quality: Sellers offer high-quality at a high price when buyers would prefer lower quality at a lower price. Before the 1970s, price floors made flights expensive, so airlines offered elaborate in-flight perks. After deregulation, in-flight perks went away—but ticket prices fell—allowing many more people to fly.

How a Price Floor Causes Inefficiency Illegal activity: Like price ceilings, price floors can incentivize illegal activity. To avoid the price floor, goods are illegally sold at low prices. For example, if the minimum wage has been set far above the equilibrium wage, workers desperate for jobs may work under the table for employers—who then conceal the labor from the government, or who may even bribe government officials.

So Why Are There Price Floors? For a influential few suppliers, price floors make a good more profitable than it would be in an unregulated market. Government officials may not believe the market is described by the supply and demand model. Officials can also misunderstand how supply and demand work.

Controlling Quantities Intending to raise the quality of its taxicabs, New York City limits the quantity of taxicabs on its streets by issuing a limited number of “medallions.” Only drivers with a medallion can offer taxicab rides. This is an example of a quantity control.

Controlling Quantities A quantity control, or quota, is an upper limit on the quantity of some good that can be bought or sold. A license gives an owner the right to supply a good or service—like the taxicab medallions in New York City.

The Anatomy of Quantity Controls The demand price of a quantity is the price at which consumers will demand that quantity. The supply price of a quantity is the price at which producers will supply that quantity.

The Anatomy of Quantity Controls Without quantity controls, the market on the right is in equilibrium. The demand price and supply price at a quantity of 10 million equals $5.00.

The Anatomy of Quantity Controls What happens to the same market with a quota set at 8 million rides? Buyers pay more than what sellers would normally accept. $ $ $ $ $ $ A quota drives a wedge between the demand price and the supply price. $ $

The Costs of Quantity Controls Deadweight loss is the value of foregone mutually beneficial transactions. Quota rent is the difference between the demand and supply price at the quota amount. The quota rent represents the increased earnings of a license-holder in a market with a quota.

The Costs of Quantity Controls To the right is the same market for rides with a quota set at 8 million rides. $ $ $ $ Deadweight loss represents the lost transactions that would have occurred without the quota. $ $ $ $

The Costs of Quantity Controls When a perfectly competitive market is in equilibrium, no deadweight loss exists. By reducing quantity and raising price, the quota causes a deadweight loss. The loss equals the value of all transactions that would’ve occurred but do not.

Summary and Review 1) What are the restrictions on how high or low a price may go? Price controls 2) Why would a government intervene in an efficient market? In fairness or to please an interest group. Option 2 for teasing the jeans narrative: cut the question & answer about jeans on the previous slide, and give it its own slide here. less clutter, but uses 2 slides. 3) What is a legally set maximum price called? A price ceiling

Summary and Review 4) Who benefits from a price ceiling? Successful buyers 5) Who loses under a price ceiling, and why? Option 2 for teasing the jeans narrative: cut the question & answer about jeans on the previous slide, and give it its own slide here. less clutter, but uses 2 slides. Those willing to pay more who cannot buy the good due to persistent shortages.

Summary and Review 6) What is a legally set minimum price called? A price floor 7) Who benefits from a price floor? Successful suppliers Option 2 for teasing the jeans narrative: cut the question & answer about jeans on the previous slide, and give it its own slide here. less clutter, but uses 2 slides. 8) Who loses from a price floor and why? Unsuccessful sellers cannot find buyers due to surpluses.

Summary and Review 9) What must be true for a price ceiling to have an effect? It must be set lower than equilibrium price. 10) What must be true for a price floor to have an effect? Option 2 for teasing the jeans narrative: cut the question & answer about jeans on the previous slide, and give it its own slide here. less clutter, but uses 2 slides. It must be set higher than equilibrium price.

Walkthrough: Free-Response Question 1 1. Refer to the graph to answer the following questions. a. What are the equilibrium wage and quantity of workers in this market? b. For it to have an effect, where would the government have to set a minimum wage? c. If the government sets the minimum wage at $8, i. how many workers would supply their labor? ii. how many workers would be hired? iii. how many workers would want to work that did not want to work for the equilibrium wage? iv. how many previously employed workers would no longer have a job? (6 points) 1 point: Equilibrium wage = $6, quantity of labor = 1,800. 1 point: 800 (the number of workers who would want to work for $8 but did not supply labor for $6). 1 point: The minimum wage will have an effect if it is set anywhere above $6. Option 2 for teasing the jeans narrative: cut the question & answer about jeans on the previous slide, and give it its own slide here. less clutter, but uses 2 slides. 1 point: 800 (at the equilibrium wage of $6, 1,800 workers were hired; at a wage of $8, 1,000 workers would be hired. 1,800 – 1,000 = 800). 1 point: 2,600 workers would supply their labor. 1 point: 1,000 workers would be hired.