Econ 101: Chapter 5

What is a price ceiling?

A maximum price sellers are allowed to charge for a good or serivce below the equilibrium price It is an upper limit

What are the three common results of price ceilings?

A persistent shortage of a good Inefficiency arising from this persistent shortage in the form of inefficiently low quantity (DWL), inefficient allocation of the good to consumers, resources wasted in searching for the good, inefficiently low quality of the good offered for sale The emergence of illegal black market activity

What are the various negative side effects of price floors?

A persistent surplus of the good Inefficiency arising from the persistent surplus in the form of inefficiently low quantity (DWL), inefficient allocation of sales among sellers, wasted resources, and an inefficently high level of quality offered by the suppliers Illegal activity

In terms of a good, what is the difference between a price ceiling and a price floor?

A price ceiling pushes the price of a good down A price floor pushes the price of a good up Both Price ceilings and floors reduce the quantity bought and sold because when the quantity of a good supplied isn't equal to the quantity demanded, the actual quantity sold is determined by the "short side" of the market-whichever quantity is less

In general when is there deadweight loss?

As long as the demand price of a given quantity exceeds the supply price, there is a deadweight loss

How is illegal activity generated from a price floor?

Ex: In europe where there are high minimum wages people are willing to work "off the books" for less money

How do you calculate the deadweight loss when a quota is in place?

Graph the supply and demand curves Calculate the equilibrium quantity DWL = ((Pc-Pp) x height (distance from equilibrium to quota)) / 2

What are the five ways that a price floor causes inefficiency?

Inefficiently low quantity Inefficient allocation of sales among sellers Wasted Resources Inefficiently high quality Illegal activity

What are the five main ways price ceilings lead to inefficiency?

Inefficiently low quantity Inefficient allocation to consumers Wasted resources Inefficiently low quality Black markets

What does a price floor do when it is imposed on the market by the government?

It creates a surplus of the good, but when the price floor is lower than the equilibrium price it is not binding and does not have an effect It means that would be sellers cannot find buyers

What does the quota rent do?

It drives a wedge between the demand price and the supply price It discourages mutually beneficial transactions, thus leading to deadweight loss

What is a black market?

It 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

Why is deadweight loss a loss to society?

It is a reduction in the total surplus, a loss in surplus that accrues to no one as a gain Its not the same a loss in surplus to one person that then accrues as a gain to someone else (thats a transfer of surplus)

What is inefficiently low quantity?

It is a result of a price ceiling, when the quantity supplied is below the equilibrium quantity Deadweight loss is the inefficiency that is created

What is quantity control or a quota?

It is an upper limit on the quantity of some good that can be bought or sold, rather than the price at which it is transacted

What is a license?

It is something (E.g. Taxi medallion) that gives its owner the right to supply a good

What is the quota rent?

It is the difference between the demand and supply price at the quota limit It is the earnings that accrue to the license-holder from the ownership of the right to sell the good-whether by actually supplying the good or by renting the license to someone else Market price of license = quota rent

What is deadweight loss?

It is the loss in total surplus that occurs whenever an action or a policy reduces the quantity transacted below the efficient market equilibrium quantity It is the loss associated with transactions that no longer occur due to market intervention

What is a price floor?

It is the minimum price buyers are required to pay for a good or service above the equilibrium price It is a lower limit

What is the demand price of a quantity?

It is the price at which consumers will demand that quantity

What us the supply price of a quantity?

It is the price at which producers will supply that quantity

What is a quota limit?

It is the total amount of a good that can be legally transacted

What is inefficent allocation to consumers?

It is when some people who are willing to pay a high price don't get something, and some people who care relatively little about the good and are only willing to pay a low price do get it

What is an example of a price floor?

Minimum wage: is a legal floor on the wage rent, which is the market price of labor

What is wasted resources?

People expend money, effort, and time to cope with the shortages caused by the price ceilings Ex: in 1979 with price controls on gas caused people to wait hours for gasoline The opportunity cost of the time spent in gas lines-the wages not earned, the leisure time not enjoyed-constituted wasted resources from the point of view of the consumers and of the economy as a whole

What does a price ceiling do to the market when imposed by the government?

Price ceilings create a shortage in the market, but when they are set above the equilibrium price they have no effect because it wont be binding

How is inefficently low quantity generated from price floors?

Price floors raise the price of a good to consumers->reduce the quantity of that good demanded because sellers cannot seller more units of a good than buyers are willing to buy which leads to deadweight loss because it reduces the quantity bought and sold A price floor that reduces the quantity below the equilibrium quantity reduces total surplus

How does a price floor lead to inefficiently high quality?

Sellers offer high quality goods at a high price, even though buyers would prefer lower quality at a lower price This represents a missed opportunity

What is inefficiently low quality?

Sellers offer low-quality goods at a low price even though buyers would prefer a higher quality at a higher price This is because the price ceiling prevents them from being compensated for doing so Ex: In rent controlled apartments landlords cannot improve the conditions of an apartment because they cannot raise rent to cover their repair costs

How do price floors generate wasted resources?

Since a surplus of the good is generated from the price ceiling being imposed, governments may buy the surplus and then destroy it They also lead to waste in time and effort Ex: would be workers spend time waiting for a job when they could potentially be doing other things

How does a price floor create these inefficiencies?

Since the price is maintained above the equilibrium price, the quantity demanded is decreased and the quantity supplied is increased compared to the equilibrium quantity

How are these inefficiencies created by price ceilings?

Since the price is maintained below the equilibrium price, the quantity demanded is increased and the quantity supplied is decreased compared to the equilibrium quantity

How are the earnings to the owner of a license accrued?

The earnings to the license owner are calculated by subtracting the supply price from the demand price P(d)-P(s) The difference is the quoya rent per unit transacted

What are price controls, and what are the two types of price controls?

They are legal restrictions on how high or low a market price may go The two types are Price ceiling Price Floor

How is inefficient allocation of sales among sellers generated from price floors?

Those who would be willing to sell the good at the lowest price are not always those who actually manage to sell it Ex: Belgium has a very high minimum wage, so jobs for young people are scare, thus leading to people who are willing to participate in illegl activity such as working for less than the minimum wage

What is a wedge?

When a quantity control, or quota drives a wedge between the demand price and the supply price of a good; that is, the price paid by the buyer ends up being higher than that received by the sellers

When do price controls come into effect?

When the government intervenes to regulate prices