Economics; Chapter 8 Price Ceilings and Floors
Price Ceilings
- A maximum price allowed by law. ->Limit the price sellers can charge for their goods to the maximum price. ->Prices cannot legally go higher than the ceiling
Price Ceilings create what effects?
1. Shortages 2. Reduction in Product Quality 3. Wasteful Lines and Other Search Costs 4. Loss of Gains from Trade 5. Misallocation of Resources
What are the effects of a price floor?
1. Surpluses 2. Loss of Gains from Trade 3. Wasteful Increases in Quality 4. Misallocation of Resources
What are misallocation of resources?
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What is a Price Floor?
A minimum price allowed by law. ->Price floors impose a minimum price that buyers must pay for goods ->Prices cannot legally go lower than the floor
What is Rent Control?
A price ceiling on housing rentals -> Prevents landlords from raising prices -> Creates larger shortages in the long run (elastic) than in the short run (inelastic)
What does a tax on buyers do?
A tax on buyers lowers the willingness to pay for every quantity demanded. ->Such a tax will shift the demand curve down by the amount of the tax. ->The tax will distort the market so that the price paid by buyers will be different than the price received by sellers.
What does a tax on sellers do?
A tax on sellers is equivalent to an increase in costs. ->Such a tax will shift the supply curve up by the amount of the tax. ->The tax will distort the market so that the price paid by buyers will be different than the price received by sellers.
What is reduction in product quality?
At the controlled price, sellers have more customers than they have goods ->In a free market, this would be an opportunity to profit by raising prices ->When prices are controlled, however, sellers cannot raise prices without violating the law
What are loss of gains from trade?
Price ceilings set below the market price cause quantity supplied to be less than the market quantity. ->For output levels below the equilibrium market quantity, consumers value the good (as indicated by the willingness to pay) more than the cost of its production. ->This represents a gain from trade that would not remain unexploited in a free market. (Deadweight loss)
What are wasteful increases in quality?
Price floors cause firms to compete by offering customers a higher quality -> would you rather have an amazing meal on the flight or more money to spend in Paris?
What are lost gains from trade?
Price floors set above the market price cause quantity demanded to be less than the market quantity. ->For output levels below the equilibrium market quantity, consumers value the good (as indicated by the willingness to pay) more than the cost of its production. ->This represents a gain from trade that would not remain unexploited in a free market. ->Price floors create a deadweight loss by forcing quantity demanded below the market quantity.
What is a Commodity Tax?
Tax placed on goods
Minimum Wage
The minimum wage is the clearest example of a price floor in the United States. ->Such a policy, however, can hurt low-skilled workers by reducing employment. ->Some economists believe that a better approach would be to subsidize employers (demanders of labor). ->This approach leads to a higher wage and a higher level of employment.
What is deadweight loss?
The total of lost consumer and producer surplus when all mutually profitable gains from trade are not exploited.
What is a surplus?
When prices are held above the market price surpluses emerge where the quantity supplied exceeds the quantity demanded. ->The surplus is measured by the difference between the quantity supplied at the controlled price and the quantity demanded at the controlled price.
What is a shortage?
When prices are held below the market price shortages emerge where the quantity demanded exceeds the quantity supplied
What is misallocation of resources?
When the price of oil is high, oil will only be used in the higher-valued uses. As the price falls, oil will also be used in lower-valued uses. Example: When it is illegal to buy or sell oil at a price above a price ceiling. No matter how cold it gets in the East, the demanders of heating oil are prevented from bidding up the price of oil, so there's no signal and no incentive to ship oil to where it is needed most.
What are Wasteful Lines?
When there are shortages lines are caused. This results in wasted time
