Ch 8: Price Ceilings are Price Floors

Price ceilings create these five important effects:

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 these four important effects:

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

Draw the price floor diagram for airlines. Explain.

A Price Floor Creates Quality Waste At the CAB-regulated fare, price is well above a seller's willingness to sell. Sellers cannot compete by offering lower prices so they compete by offering higher quality. Higher quality raises costs and reduces seller profit. Buyers enjoy the higher quality, but would prefer less quality at a lower price. Thus, the price floor encourages sellers to waste resources by producing more quality than buyers are willing to pay for.

What is a price floor?

A legal minimum on the price at which a good can be sold

If sellers have more customers than they have goods, they would normally raise prices. Why can't they do this under a price ceiling? What do they do instead?

Against the law; cut quality

What is the difference between a binding and non-binding price ceiling?

Binding price ceiling is set below market equilibrium; non-binding is set above

Imagine that it's sunny on the West Coast of the US but on the East Coast a cold winter increases the demand for heating oil. What would happen in a market with 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. Oil is misallocated. Swimming pools in California are heated, while homes in New Jersey are cold.

Do price controls eliminate competition?

No. They merely change the form of competition

What is the difference in paying in bribes vs. paying in time? Explain

Paying in time is much more wasteful; with bribes, at least the gas station owner gets the bribe. Time spent waiting in line is simply lost

Imagine that it's sunny on the West Coast of the US but on the East Coast a cold winter increases the demand for heating oil. What would happen in a market without price controls?

The increase in demand in the East pushes up prices in the East. Eager for profit, entrepreneurs buy oil in the West, where the oil is not much needed and the price is low, and they move it to the East, where people are cold and the price of oil is high. In this way, the price increases in the East is moderated and supplies of oil move to where they are needed most.

What happens to gains from trade under price controls?

They are reduced

How do firms compete when they cannot lower prices?

They offer customers higher quality

What are price ceilings?

a maximum price that can be legally charged for a good or service

Give two examples of how buyers compete when there is a price ceiling

by paying bribes or by willingness to wait in line

At the controlled price of the price ceilings, demanders find that they ____________ and sellers find that ___________. In other words, sellers have __________ customers than they have __________

cannot buy as much of the good as they would like; there is an excess of demand; sellers have more customers than they have goods

Draw the graph for price floor of quantity of labor vs. wage and include DWL. What does the lost consumer surplus correspond to? Lost producer surplus?

employers (consumers of labor); worker

Without market prices, there is no guarantee that oil will flow to its _______

highest-value uses

regulation of entry into the airline industry didn't just increase prices, it ________

it increased costs and reduced innovation. Deregulation improved the allocation of resources by allowing low-cost, innovative firms to expand nationally.

The most common example of a price being controlled above market levels is ____

minimum wage

What is deadweight loss?

the total of lost consumer and producer surplus when not all mutually profitable gains from trade are exploited

The total value of wasted time is given by _________. use gasoline as an example and draw the diagram

time cost per gallon multiplied by the quantity of gallons bought

What is a surplus of labor called?

unemployment