ECON 2105 Chapter 4

How do price ceilings cause inefficiency

1. Inefficiently Low Quantity - With a price ceiling that is below the equilibrium price, the amount bought and sold in the market is defined by the quantity supplied. The efficient quantity bought and sold would be the equilibrium quantity at the equilibrium price, but with a price ceiling there are many mutually beneficial trades that do not occur(slides 11-14) 2. Inefficient Allocation to Consumers - Price ceilings often lead to inefficiency in the form of inefficient allocation to consumers: people who want the good badly and are willing to pay a high price don't get it, and those who care relatively little about the good and are only willing to pay a low price do get it. 3. Wasted Resources - Price ceilings typically lead to inefficiency in the form of wasted resources: people expend money, effort, and time to cope with the shortages caused by the price ceiling. 4. Inefficiently low quality - Price ceilings often lead to inefficiency in that the goods being offered are of inefficiently low quality: sellers offer low-quality goods at a low price even though buyers would prefer a higher quality at a higher price. 5. Black Markets - A black market is a market in which goods or services are bought and sold illegally—either because it is illegal to sell them at all or because the prices charged are legally prohibited by a price ceiling.

price controls

The government intervenes to regulate prices by imposing price controls, which are legal restrictions on how high or low a market price can go the government may do this in order to keep the market price at a level in which the quantityy supplied equals the quantity demanded (equilibrium price)

How a Price Floor Causes Inefficiency

The persistent surplus that results from a price floor creates missed opportunities—inefficiencies—that resemble those created by the shortage that results from a price ceiling. These include: - Inefficiently low quantity - With a price floor that is above the equilibrium price, the amount bought and sold in the market is defined by the quantity demanded. The efficient quantity bought and sold would be the equilibrium quantity at the equilibrium price, but with a price floor there are many mutually beneficial trades that do not occur. slides 23-27 - Inefficient allocation of sales among sellers - Price floors lead to inefficient allocation of sales among sellers: those who would be willing to sell the good at the lowest price are not always those who actually manage to sell it. - Wasted resources - Inefficiently high quality - Price floors often lead to inefficiency in that goods of inefficiently high quality are offered: sellers offer high-quality goods at a high price, even though buyers would prefer a lower quality at a lower price. - Temptation to break the law by selling below the legal price

To find the market outcome after a price ceiling is put in place (below the equilibrium always causes shortages)

calculate the deadweight(area not used by consumer or producer surplus, by finding the area. slide 17

With a quota, some economic surplus is transferred from ________ to ________.

consumers to producers

The demand price of a given quantity is

the price at which consumers will demand that quantity.

The supply price of a given quantity is

the price at which producers will supply that quantity

A quantity control, or quota, is an upper limit on the quantity of some good that can be bought or sold.

upper limit on the quantity of some good that can be bought or sold. The total amount of the good that can be legally transacted is the quota limit. An example is the taxi medallion system in New York.

Licensing is an

indirect way to control quantity. A license gives its owner the right to supply a good.

price ceiling

*is the maximum price sellers are legally allowed to charge for a good or service. keeps the price of a good down. If the ceiling is below the equilibrium price: Sellers won't want to sell as much as buyers want to buy → shortage.* a type of price control Price ceilings are typically imposed during crises—wars, harvest failures, natural disasters—because these events often lead to sudden price increases that hurt many people but produce big gains for a lucky few. - Examples: The U.S. government imposed ceilings on aluminum and steel during World War II; rent controls in New York City If the price ceiling is set lower than the eq price then it causes shortages.** slide 7 If the price ceiling is set higher than the equilibrium price, it is said to be non-binding, and has no distortionary effect on the market. slide 8

price floor

*is the minimum price buyers are legally required to pay for a good or service. keeps the price of a good up. If the floor is above the equilibrium price: Buyers won't want to buy as much as sellers want to sell → surplus.* a type of price control Sometimes governments intervene to keep market prices up instead of down. The minimum wage is a legal floor on the wage rate, which is the market price of labor. - Historically, price floors have often been implemented in agricultural markets, to keep the prices of various crops artificially high. Just like price ceilings, price floors are intended to help some people but generate predictable and undesirable side effects. If the price floor is set higher than the eq price then it causes surpluses.** If the price floor is set below than the equilibrium price, it is said to be non-binding, and has no distortionary effect on the market. slide 21