Chapter 5

Inefficient Allocation of Sales Among Sellers

Price floors can lead to this. Sellers who are willing to sell at the lowest price are unable to make sales while sales go to sellers who are only willing to sell at a higher price.

Wedge

A quantity control, or quota, drives this between the demand price and the supply price of a good; that is, the price paid by buyers ends up being higher than that received by sellers. The wedge is equal to the quota rent.

Minimum Wage

A legal floor on the wage rate, which is the market price of labor. The most well known kind of price floor.

Black Market

A market in which goods or services are brought and sold illegally-either because it is illegal to sell them at all or because the prices charged are legally prohibited by price ceiling.

Quantity Control (Quota)

An upper limit on the quantity of some good that can be bought or sold. Lead to deadweight loss in addition to encouraging illegal activity.

License

Gives its owner the right to supply a good.

Wasted Resources

Price ceilings typically lead to this inefficiency. People expend money, effort, and time to cope with the shortages caused by the price ceiling.

Price Controls

Legal restrictions on how high or low a market price may go.

Price Ceiling

One of the two forms price controls can take where there's a maximum price sellers are allowed to charge for a good or service. This benefits successful buyers but creates persistent shortages. Because the price is maintained below the equilibrium price, the quantity demanded is increased and the quantity supplied is decreased compared to the equilibrium quantity. This leads to predictable problems and because of these problems, price ceilings have generally lost favor as an economic policy tool. But some governments continue to impose hem either because they don't understand the effects or because the price ceilings benefit some influential group.

Price Floor

One of the two forms price controls can take where there's a minimum price sellers are allowed to charge for a good or service. Benefits successful sellers but creates persistent surplus. Because the price is maintained above the equilibrium price, the quantity demanded is decreased and the quantity supplied is increased compared to the equilibrium quantity. Applied to agricultural products often, This leads to predictable problems.

Inefficiently Low Quality

Price ceilings often lead to this inefficiency. Goods that are being offered by sellers are low-quality goods at a low price even though buyers would prefer a higher quality at a higher price.

Inefficient Allocation to Consumers

Price ceilings often lead to this inefficiency. Some people who want the good badly and are willing to pay a high price don't get it, and some who care relatively little about the good and are only willing to pay a low price do get it.

Inefficiently High Quality

Price floors often lead to this inefficiency. These goods offered by sellers are high-quality goods at a high price, even though buyers would prefer a lower quality at a lower price.

Quota Rent

The difference between the demand and supply price at the quota limit. This is the earnings that accrue to the license-holder from ownership of the right to sell the good. It is equal to the market price of the license when the licenses are traded.

In order to ingratiate himself with voters, the mayor of Gotham City decides to lower the price of taxi rides. Assume, for simplicity, that all taxi rides are the same distance and therefore cost the same. The accompanying table (See Notes) shows the demand and supply schedules for taxi rides. Assume that there are no restrictions on the number of taxi rides that can be supplied (there is no medallion system). Find the equilibrium price and quantity.

The equilibrium in the market for taxi rides is shown by E1 in the accompanying diagram. The equilibrium price is $6.50; at that price, the quantity demanded equals the quantity supplied—11 million taxi rides per year. The demand and supply curves (D1 and S) illustrate this initial situation.

Deadweight Loss

The loss in total surplus that occurs whenever an action or a policy reduces the quantity transacted below the efficient market equilibrium quantity.

In order to ingratiate himself with voters, the mayor of Gotham City decides to lower the price of taxi rides. Assume, for simplicity, that all taxi rides are the same distance and therefore cost the same. The accompanying table (See Notes) shows the demand and supply schedules for taxi rides. Suppose that the stock market crashes and, as a result, people in Gotham City are poorer. This reduces the quantity of taxi rides demanded by 6 million rides per years at any given price. What effect will the mayor's new policy have now? Illustrate with a diagram.

The new demand curve is D2. Now the price ceiling has no effect: the equilibrium is point E2 and the market price settles at $5, which is below the mandated price ceiling of $5.50. There will be 8 million taxi rides demanded and supplied, at a price of $5 each.

Demand Price of a Given Quantity

The price at which consumers will demand that quantity.

Supply Price of a Given Quantity

The price at which producers will supply that quantity.

In order to ingratiate himself with voters, the mayor of Gotham City decides to lower the price of taxi rides. Assume, for simplicity, that all taxi rides are he same distance and therefore cost the same. The accompanying table (See Notes) shows the demand and supply schedules for taxi rides. Suppose that the stock market rises and the demand for taxi rides returns to normal (that is, returns to the demand schedule given in the table). The mayor now decides to ingratiate himself with taxi drivers. He announces a policy in which operating licenses are given to existing taxi drivers; the number of licenses is restricted such that only 10 million rides per year can be given. Illustrate the effect of this policy on the market, and indicate the resulting price and quantity transacted. What is the quota rent per ride?

The quantity of taxi rides is now 10 million, at a price of $7. The quota rent per ride is $1.

Quota Limit

The total amount of the good that can be legally transacted.

Why do governments intervene even when a market is efficient and how do they do so?

To pursue greater fairness or to please a powerful interest group. Interventions can take the form of price control or quantity controls, both of which generate predictable and undesirable side effects consisting of various form of inefficiency and illegal activity.

In order to ingratiate himself with voters, the mayor of Gotham City decides to lower the price of taxi rides. Assume, for simplicity, that all taxi rides are the same distance and therefore cost the same. The accompanying table (See Notes) shows the demand and supply schedules for taxi rides. Suppose that the mayor sets a price ceiling at $5.50. How large is the shortage of rides? Illustrate with a diagram. Who loses and who benefits from this policy?

With a price ceiling of $5.50, the quantity supplied is 9 million taxi rides and the quantity demanded is 13 million. The shortage therefore is 13 million − 9 million =4 million. Taxi drivers clearly lose out: there are fewer taxi rides supplied than before, and at a lower price. The impact on consumers is unclear: fewer people now manage to get rides, but those who do, get them at a lower price