Ch. 8 Book Notes - Econ

Price Ceilings

1. Shortages 2. Reductions in product quality 3. Wasteful lines and other search costs 4. A loss of gains from trade 5. A misallocation of resources

Price floors create four important effects:

1. Surpluses 2. Lost gains from trade (deadweight loss) 3. Wasteful increases in quality 4. A misallocation of resources

Reductions in Quality

At the controlled price, demanders find that there is - a shortage of goods - excess of demand Ordinarily, this would be an opportunity to profit by raising prices, but when prices are controlled, sellers can't raise prices without violating the law. It's much easier to evade the law by cutting quality than by raising price, so when prices are held *below market levels*, *quality declines* - less of an item, reduction in service

Price Floors

a minimum price allowed by law When governments control prices, it is usually with a price ceiling designed to keep prices below market levels, but occasionally the government intervenes to keep prices above market levels. ex. labor/minimum wage

Longer term solution for low full-time earnings is

improved education and training The market pricing human capital - Signaling value

A price floor is a _____ price allowed by law.

minimum And price floors cause surpluses.

with a price ceiling in place, demanders could not

signal their need to suppliers nor could they provide suppliers with an incentive to produce more

One of the primary reasons for price controls may be that

the public, unlike economists, does not see the consequences of price controls

deadweight loss def

the reduction in total surplus caused by a market distortion or inefficiency

Price controls do not eliminate competition.

Difference between paying in bribes and paying in time: Paying in time is much more wasteful. When a buyer bribes a gasoline station owner $40, at least the gasoline station owner gets the bribe. But when a buyer spends $40 worth of time or four hours waiting in line, the gasoline station owner doesn't get to add four hours to his life.

A Targeted Alternative to Minimum Wage

Earned Income Tax Credit (EITC) - Low-income, low-wage workers receive refunable tax credits - No dis-employment effect (it is a subsidy to hire low wage workers) - Wages can still adjust

Price floor: Lost Gains from Trade (Deadweight Loss)

If employers and workers could bargain freely, the wage would fall and the quantity of labor traded would increase to the level of market employment.

Rent Regulation

In the 1990s, many American cities with rent control changed policy and began to eliminate or ease rent controls. Some economists refer to these new policies not as rent control but as "rent regulation." A typical rent regulation limits price increases without limiting prices. Price increases, for example, might be limited to, say, 10% per year. Thus, rent regulations can protect tenants from sharp increases in rent, while still allowing prices to rise or fall over several years in response to market forces.

Rent: Wasteful Lines, Search Costs, and Lost Gains from Trade

Landlords prefer to rent to people who are seen as being more likely to pay the rent on time and not cause trouble for other tenants, for example, older, richer couples without children or dogs. Landlords might also discriminate on racial or other grounds. Bribing the landlord or apartment manager to get a rent-controlled apartment is also common. Bribes are illegal but they can be disguised. An apartment might rent for $500 a month but come with $5,000 worth of "furniture."

Price Ceiling def

a maximum price allowed by law

Wasteful Lines and Other Search Costs

Price Ceilings Create Wasteful Lines ex. Suppose that buyers value their time at $10 an hour and, as before, the average fuel tank holds 20 gallons. Eager to obtain gas during the shortage, a buyer arrives at the station early, perhaps even before it opens, and must wait in line for an hour before he is served. His total price of gas is $30: $1 per gallon for 20 gallons in out-of-pocket cost plus $10 in time cost. Since the total value of the gas is $60, that's still a good deal.

Lost Gains from Trade (Deadweight Loss)

Price controls also reduce the gains from trade. Buyers and sellers want to trade, but they are prevented from doing so by the threat of jail. If the price ceiling were lifted and trade were allowed, the quantity traded would expand

Misallocation of Resources

Price controls distort signals and eliminate incentives ex. Swimming pools in California are heated, while homes in New Jersey are cold. in a market with a price ceiling, demanders with the highest willingness to pay have no easy way to signal their demands nor do suppliers have an incentive to supply their demands. As a result, in a controlled market goods are misallocated. High-valued uses are at the top of the curve and low-valued uses at the bottom. Without market prices, however, we have no guarantee that oil will flow to its highest-valued uses.

Housing vouchers

Price controls, however, are never the only way to help the poor and they are rarely the best way. If affordable housing is a concern, for example, then a better policy than rent controls is for the government to provide housing vouchers. are used extensively in the United States, give qualifying consumers a voucher worth, say, $500 a month that can be applied to any unit of housing. Unlike rent controls, which create shortages, vouchers increase the supply of housing. There are a few other sound arguments for price controls. The best case for price controls is to discipline monopolies.

Arguments for and against min wage and min wage increases

Pro: Fairness - Goal is to help low-wage workers - Some will lose, but benefits exceed cost (SR demand is inelastic) - Politically popular Against: Fairness - Least-skilled workers are the most likely to become unemployed - Impedes training and employment opportunities for the least-skilled (long-run demand elasticity is greater) -- Internships for college students?

Rent: Shortages

Rent controls usually begin with a "rent freeze," which prohibits landlords from raising rents. Controlled rent ends up below market equilibrium rent Apartments are long-lasting goods that cannot be moved, so when rent controls are first imposed, owners of apartment buildings have few alternatives but to absorb the lower price. In other words, the short-run supply curve for apartments is inelastic. In the long run, however, fewer new apartment units are built and older units are turned into condominiums or torn down to make way for parking garages or other higher-paying ventures. Thus, the long-run supply curve is much more elastic than the short-run supply curve, and the shortage grows over time from the short-run shortage to the long-run shortage.

Price Floors: The Misallocation of Resources

Restrictions on entry misallocated resources because low-cost airlines were kept out of the industry. Southwest Airlines, for example, began as a Texas-only airline because it could not get a license from the CAB to operate between states. The entry of Southwest was not just a case of increasing supply. One of the virtues of the market process is that it is open to new ideas, innovations, and experiments. Southwest, for example, pioneered consistent use of the same aircraft to lower maintenance costs, greater use of smaller airports like Chicago's Midway, and long-term hedging of fuel costs.

Misallocation and Production Chaos

Shortages in one market create breakdowns and shortages in other markets, so the chaos of price controls expands even into markets without price controls.

Arguments for Price Ceilings

Without price controls on oil in 1973, some people might not have been able to afford to heat their homes. Without rent controls, some people may not be able to afford appropriate housing. It's not obvious that the poor are better off with shortages than with high prices. Nevertheless, if price controls were the only way to help the poor, then this would be an argument in favor of price controls.

blat

a connection and something to trade ex. If the manager can find a worker in a beef factory who loves music

Universal Price Controls

We have seen that price controls in the United States caused shortages, lineups, delays, quality reductions, misallocations, bureaucracy, and corruption.

Shortages

When prices are held below the market price, the quantity demanded exceeds the quantity supplied. measured by the difference between the quantity demanded at the controlled price and the quantity supplied at the controlled price the lower the controlled price is relative to the market equilibrium price, the larger the shortage

rent control

a price ceiling on rental housing a price ceiling on rental housing

Rent: Misallocation of Resources

apartments under rent control are allocated haphazardly—some people with a high willingness to pay can't buy as much housing as they want, even as others with a low willingness to pay consume more housing than they would purchase at the market rate. ex. the older couple who stay in their large rent-controlled apartment even after their children have moved out

No market prices = no guarantee that oil will flow to its highest-valued uses

potential consumers of the oil with the highest-valued uses are legally prevented from signaling their high value by offering to pay oil suppliers more than the controlled price. Oil suppliers, therefore, have no incentive to supply oil to just the highest-valued uses. Instead, oil suppliers will give the oil to any user who is willing to pay the controlled price—but most of these users of oil have lower-valued uses when the supply of oil is reduced and there are price ceilings, oil is allocated according to random and often trivial factors A more realistic assumption is that under price controls, goods are allocated randomly so that a high-valued use is as likely as a low-valued use to be satisfied.

Price Floor: Wasteful Increases in Quality

price floor encourages sellers to waste resources by producing more quality than buyers are willing to pay for. The price floor, however, makes it illegal to compete for more customers by lowering prices. So how do firms compete when they cannot lower prices? Price floors cause firms to compete by offering customers higher quality. An increase in quality that consumers are not willing to pay for is a wasteful increase in quality. Thus, as firms competed by offering higher quality, the initial producer surplus was wasted away in frills that consumers liked but would not be willing to pay for

Surpluses

quantity of labor supplied exceeds the quantity demanded ex. unemployment A minimum wage of $7.25 an hour, the federal minimum in 2017, won't affect most workers who, because of their productivity, already earn more than $7.25 an hour. A minimum wage, however, will decrease employment among low-skilled workers. The more employers have to pay for low-skilled workers, the fewer low-skilled workers they will hire.

Price floors and ceilings both

reduce gains from trade

Rent: Reductions in Product Quality

reduce housing quality, especially the quality of low-end apartments When the price of apartments is forced down, owners attempt to stave off losses by cutting their costs. With rent controls, for example, owners mow the lawns less often, replace lightbulbs more slowly, and don't fix the elevators so quickly.

We can now see that in a market with a price ceiling, the sum of consumer and producer surplus is not maximized because

the price control prevents mutually profitable gains from trade from being exploited.