05 Prices Controls
pg142-170
Misconception - Rent controls help make housing more affordable for everyone.
When Do Price Ceilings Matter?
- Price controls attempt to set prices through government involvement in the market.
- A price ceiling is a legally established maximum price for a good or service.
- Black market is illegal markets that arise when price controls are in place.
Understanding Price Ceilings
To help disadvantaged, legislators pass a law stating that no one can charge more than $0.5 for a loaf of bread. (this price ceiling is about one-third the typical price of a loaf of generic white bread.
Table 5.1
A Price Ceiling on Bread
| Question | Answer/Explanation | Result |
|---|---|---|
| Will there be more bread or less bread for sale? | Consumers will want to buy more because the price is lower (the law of demand), but producers will manufacture less (the law of supply). The net result will be a shortage of bread. | Empty Shelves |
| Will the size of a typical loaf of bread change? | Because the price is capped at $0.5 per load, manufacturers will try to maintain profits by reducing the size of each loaf. | No more giant bread. |
| Will the quality change? | Because the price is capped, producers will use cheaper ingredients, and many expensive brands and varieties will no longer profitable to produce. Thus the quality of available bread will decline. | Focaccia bread will disappear. |
| Will the opportunity cost of finding bread change ? | The opportunity cost of finding bread will rise. Consumers will spend significant resources going from store to store to see if a bread shipment has arrived and waiting in long line for a change to get some. | Bread lines will become the norm. |
| Will people break the law to buy bread? | Because bread will be hard to find and people still need it, a black market will develop. Those selling and buying on the black market will be breaking the law. | Black market dealers will help reduce the shortage. |
The Effect Of Price Ceilings
- Nonbinding Price Ceilings
When a price ceiling is above the equilibrium price, we say it is nonbinding. The price ceiling does not influence the market. As long as the equilibrium price remains below the price ceiling, price will continue to be regulated by supply and demand.
Figure 5.1 A Nonbinding price ceiling
- Binding Price Ceilings
When a price ceiling is below the market price, it creates a binding constraint that prevents supply and demand from clearing the market. The prices ceiling is binding.
The price ceiling has created two unintended consequences: a smaller quantity of bread supplied and a higher price for those who purchase it on the black market.
Figure 5.2 The Effect of a Binding price ceiling in the Short Run
Price Ceilings in the Long Run
In the long run, supply and demand become more elastic, or flatter.
Economics In the Media
Price Ceilings
Moscow on the Hudson
When Effects Do Price Ceilings Have on Economic Activity?
Rent Control
Rent Control is a price ceiling that applies to the market of apartment rentals.
In Mumbai, India, many rent-controlled buildings have dilapidated. (low profit -> ill-maintained building -> tragic consequences every monsoon season.)
Price Gouging
- Price gouging laws places a temporary ceiling on the prices that seller can charge during times of emergency.
Figure 5.5
Price Gouging
Price gouging laws serve as a nonbinding price ceiling during normal times. However, when a natural disaster strikes, price gouging laws go into effect, the demand curve for generator shifts to the right as a result of the natural disaster, causing the new equilibrium price (E_after) to rise above the legal limit. The result is a shortage. When the emergency is lifted, the market demand returns to normal, and the temporary shortage created by price gouging legislation is eliminated.
When Do Price Floors Matter?
- A price floor is a legally established minimum price for a good or service.
A politician suggests we should encourage dairy farmers to produce more milk so that supplies will be plentiful and everyone will get enough calcium. To accomplish these goals, the government sets a price floor of $6 per gallon-about twice the price of a typical gallon of fat-free milk-to make production more attractive to milk producers, What repercussions should we expect?
Understanding Price Floors
Table 5.2
| Questions | Answer/Explanation | Result |
|---|---|---|
| Will the quantity of milk for sale change? | Consumer will purchase less because the price is higher (the law of demand), but producers will manufacture more (the law of supply). The net result will be a surplus of milk. | There will be a surplus of milk. |
| Would producers sell below the price floor? | Yes. A surplus of milk would give sellers a strong incentive to undercut the price floor to avoid having to discard leftover milk. | Illegal discounts will help reduce the milk surplus. |
| Will dairy farmers be better off? | Not if they have trouble selling what they produce. | There might be a log of spoiled milk. |
The Effect Of Price Floors
Nonbinding Price Floors
Figure 5.6
A Nonbinding Price Floor
Under a nonbinding price floor, price is regulated by supply and demand. Because the price floor ($2) is below the equilibrium price ($3), the market will voluntarily charge more than the legal minimum. Therefore, this nonbinding price floor will have no effect on sales and purchase of milk.
Binding Price Floors
Figure 5.7
A Binding Price Floor
A binding price floor creates a surplus, which has two unintended consequences: (1) a smaller quantity demanded than the equilibrium quantity (Q_Dsr < Q_Esr) and (2) a lower black-market price to eliminate the glut of the product.
Price Floors in the Long Run.
Figure 5.8
The Effect of Binding Price Floor in the Long Run
When a price floor is left in place over time, supply and demand both become more elastic. The result is a larger surplus (Q_SLR > Q_DLR) in the long run. Because sellers are unable to sell all that they produce at $6 per gallon, a black market develops to eliminate the glut of milk.
When Effects Do Price Floors Have on Economic Activity?
The Minimum Wage
- The minimum wage is the lowest hourly wage rate that firms may legally pay their workers.
Figure 5.9
Price Floor and a Binding Minimum Wage Market in the Short Run and Long Run
A binding minimum wage is a price floor above the current equilibrium wage, W_E. At $10 per hour, the number of workers willing to supply their labor () is greater than the demand of workers (). The result is a surplus of workers (which we recognize as unemployment ). Because the supply of workers both become more elastic in the long run, unemployment expands ().
Economics In the Real world
Wage Laws Squeeze South Africa's Poor
The Minimum Wage is Often Nonbinding
Figure 5.10
A Nonbinding Minimum wage
An increase in the minimum wage from $7 to $9 remains nonbinding. Therefore, it will not change the demand for labor or the unemployment rate. If the minimum wage rises above the market wage, unemployment will occur.
Economics In The Real World
A Sweet Deal, If You Can Get It
Coca-Cola, high-fructose corn syrup, sugar, Latin America
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