1. Slide 1 of 36 Modern Principles: Macroeconomics Tyler Cowen and Alex Tabarrok Copyright © 2010 Worth Publishers Modern Principles: Macroeconomics Cowen/Tabarrok Price Ceilings and Price Floors

2. Slide 2 of 36 Price Ceilings Price controls create price ceilings when the controlled price is below the market equilibrium price. Price ceilings create important consequences: 1.Shortages 2.Reductions in product quality.

3. Slide 3 of 36 Price Ceilings 1.Shortages Quantity Price ($) Demand Supply Market equilibrium Controlled price (ceiling) Quantity demanded at the controlled price Quantity supplied at the controlled price Shortage Results: 1.At the controlled price Q s < Q d 2.In 1973, there were shortages of wool, copper, aluminum, vinyl, denim jeans, paper, …

4. Slide 4 of 36 Price Ceilings 2.Reductions in Product Quality  One way to evade the law is to cut quality.  Examples from the 1970s: Books were printed on lower quality paper. 2" X 4" lumber shrank to 1⅝" X 3⅝" New automobiles were painted with fewer coats of paint.  Another way quality can fall is to cut service.  Examples from the 1970s The full service gasoline state disappeared.* Gasoline stations would close whenever the owner wanted a break.

5. Slide 5 of 36  Since World War II, New York City has had rent control, with ceilings placed on the rent that apartment landlords can charge. You are moving to New York City. Will you find a surplus or shortage of apartments?  Some landlords in New York City demand that new tenants pay $500 or $1000 key money: landlords will not hand over a set of apartment keys until this non-refundable payment is made. How does key money fit in our model of the effects of price ceilings?

6. Slide 6 of 36  In rent-controlled New York City, over time, what do you think will happen to the upkeep of the rent-controlled buildings? What is the landlord’s incentive structure?

7. Slide 7 of 36 Price Floors A price floor is a minimum price allowed by law. The best example of a price floor is the minimum wage. Price floors create an important effect: Surpluses.

8. Slide 8 of 36 Price Floors 1.Surpluses  Minimum wage leads to a surplus of labor (unemployment).  Higher productivity workers are unaffected.  Minimum wage leads to ↓ employment among younger workers Young people lack skills and experience More than half of minimum wage workers are younger than 25 years old.  The following diagram shows the effect of a price floor (minimum wage)

9. Slide 9 of 36 Price Floors 1.Surpluses (cont.) Wage ($) Quantity Supply Demand Market employment Minimum wage (floor) Quantity demanded at minimum wage Quantity supplied at minimum wage Market wage Labor surplus (Unemployment) Conclusion: the greater the difference between the minimum wage and the market wage, the greater is unemployment

10. Slide 10 of 36  The European Union has a minimum legal price for butter, a price floor, that is often above the market equilibrium price. What do you think has been the result of this?  The U.S. has set a price floor for milk above the equilibrium price. Has this led to shortages or surpluses? How do you think the U.S. government has dealt with this? (Hint: remember the cartons of milk you had in grammar school and high school? What was their price?

11. Slide 11 of 36  Takeaway You should be able to:  draw a diagram showing the price ceiling and correctly labeling the shortage You should also understand how price ceilings…  Reduce product quality.  Cause shortages.

12. Slide 12 of 36  Takeaway Using the tools of supply and demand you should be able to…  Explain why a price floor creates a surplus.  Label these areas on a diagram.