chapter 8: Price ceilings and floors

how does Hedrick smith describe "blat"?

"the more rank and power one has, the more blat one normally has . . . each has access to things or services that are hard to get and that other people want or need"

5 important effects of 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

do price ceiling reduce or increase the gains from trade?

A Price Ceiling Reduces the Gains from Trade

how does A Price Floor Reduce the Gains from Trade?

At the minimum wage, employers are willing to hire more workers at just less than the minimum wage and workers are willing to work additional hours for just more than W0. Although mutually profitable, these trades are illegal. If all mutually profitable trades were legal, the gains from trade would increase by the green plus blue triangles.

blat

Blat is a Russian word meaning one has connections that can be used to get favors.

With all goods in permanent shortage, how did anyone in the Soviet Union obtain goods?

By using blat.

what were major problems during the gasoline shortages of the 1970s?

Corruption and bribes

democratic stance on minimum wage

Democrats often argue that the minimum wage must be raised to help working families.

why do economists call is a "price floor"?

Economists call it a price floor because prices cannot legally go below the floor.

example of how the US used blat in the 1970s oil crisis

Firms began to hire former politicians and bureaucrats who used their connections to help the firms get more oil.

better alternative to price controls to aid people in affordable housing

Housing vouchers -give qualifying consumers a voucher worth, say, $500 a month that can be applied to any unit of housing. -vouchers increase the supply of housing. Vouchers can also be targeted to consumers who need them

example of surge price with uber:

If a big concert has just ended or if it's raining, then demand may be especially high and Uber will often charge a higher price -higher prices incentivize drivers to drive where and when demand has increased

what is meant by In a Free Market Goods Flow to Their Highest-Value Uses

If all units of the good are allocated to the highest-valued uses, then consumer surplus is the area between the demand curve and the price up to the quantity supplied.

example of negative effects of shortages on other markets without price controls:

In 1973, for example, million-dollar construction projects were delayed because a few thousand dollars worth of steel bar was unavailable

do rent shortages create larger shortages in the long run or short run?

Long Run -The short-run shortage is small since the apartment units are already built. In the long run, fewer new units are built and old apartments are torn down or turned into condominiums so the long-run shortage is much greater.

example of how price controls show oil is misallocated

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.

do price controls eliminate competition?

No. They merely change the form of competition.

when were price controls for most goods lifted?

Price controls for most goods were lifted by April 1974

when did price controls on oil end?

Price controls on oil ended as abruptly as they had begun when on the morning of January 20, 1981, when Ronald Reagan was inaugurated as president

how do firms compete when they cannot lower prices?

Price floors cause firms to compete by offering customers higher quality.

what do rent controls ensue?

Rent controls create shortages, reduce quality, create wasteful lines and increase the costs of search, cause a loss of gains from trade, and misallocate resources.

republican stance on minimum wage

Republicans respond that a higher minimum wage will create unemployment and raise prices as firms pass on higher costs to customers.

negative effects of shortages on other markets without price controls:

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

example of command economy with price controls

Soviet Union

how does minimum wage decrease employment among low-skilled workers?

The more employers have to pay for low-skilled workers, the fewer low-skilled workers they will hire.

how did this new two tier system of oil create wasteful gaming?

The two-tier system, however, also created wasteful gaming as firms shut down some oil wells only to drill "new" wells right next door

how do Price Ceilings Create Wasteful Lines?

Time spent waiting in line is wasted time. The total value of wasted time is given by the time cost per gallon multiplied by the quantity of gallons bought.

examine of how firms use higher quality to compete when a price floor is in place:

When airlines were regulated, for example, they competed by offering their customers bone china, fancy meals, wide seats, and frequent flights

price ceiling

When the maximum price that can be legally charged is below the market price

price floor

When the minimum price that can be legally charged is above the market price

how do rent controls reduce the quality of housing?

When the price of apartments is forced down, owners attempt to stave off losses by cutting their costs; thus, decreasing quality.

what does it mean when the demand for oil depends on the value of oil in different uses?

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 of Consumer Surplus Falling Under Random Allocation

When there is a price control, the buyers with the highest-valued uses cannot outbid other buyers, so goods will flow to any buyer willing to pay more than the controlled price of $6. If goods are allocated randomly to buyers with values between $30 and $6, the average value will be $18. Consumer surplus under random allocation is the green area. If goods were allocated to the highest-valued uses, consumer surplus would be larger, the red plus green areas. Thus, a price control misallocates resources, reducing consumer surplus.

Is there another way that sellers can increase profits without violating the law?

Yes. 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

Is there a difference between paying in bribes and paying in time?

Yes. 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

rent control

a price ceiling on rental housing,

result of uber adjusting their prices:

anyone can get a ride fairly quickly so long as they are willing to pay the price.

What does an increase in quality that consumers are not willing to pay for is a wasteful increase in quality entail?

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 fo

explain how A Price Floor Creates a Surplus (Minimum Wages Create Unemployment)

at the minimum wage, the quantity demanded of labor falls below the market employment level and the quantity supplied rises, creating a surplus of labor.

how did Restrictions on entry of airline firms misallocate resources?

because low-cost airlines were kept out of the industry.

who gets the gasoline in a price controlled economy?

buyers now competed in waiting in longer lines (the price paid in peoples' time increased

what reason accounts for why flying is an ordinary event for most American families, rather than the province of the wealthy.

deregulation

alternative to employing minimum wage jobs when the wage increases:

firms can substitute capital—in the form of machines—for labor.

effect of deregulation on goods?

improved the allocation of resources by allowing low-cost, innovative firms to expand nationally

elaboration of how in a controlled market goods are misallocated

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.

Effect of regulation on goods?

it increased costs and reduced innovation.

what happened in the 1990s with rent regulations?

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."

Price controls mean that oil is ______.

misallocated.

What would happen if price controls on all goods remained in place for a lengthy period of time?

never-ending shortages would occur -this meant that lining up for hours to get bread, shoes, or other goods was normal.

what do price ceilings create?

shortages -At the controlled price, the quantity demanded exceeds the quantity supplied, creating a shortage.

result of no rent controls?

some people may not be able to afford appropriate housing.

result of not having price controls on oil in 1973?

some people might not have been able to afford to heat their homes.

misallocation of resources in regards to rent

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

under the influence of older airlines, what did CAB do?

the CAB routinely prevented new competitors from entering.

most serious shortage during the 1970s

the OPEC embargo in 1973 and the reduction in supply caused by the Iranian Revolution in 1979 increased the world price of oil,

example of blat

the manager of a radio store wants beef: If the manager can find a worker in a beef factory who loves music, he will have blat, a connection and something to trade.

most common example of a price that is controlled above the market level is

the minimum wage

how does a Price Floor Create Quality Waste?

the price floor encourages sellers to waste resources by producing more quality than buyers are willing to pay for.

how does a price ceiling reduce the gains from trade?

the sum of consumer and producer surplus is not maximized because the price control prevents mutually profitable gains from trade from being exploited.

result of price controls of oil being lifted in the US?

there has been no shortage of oil

what happens to oil suppliers when there is a price ceiling put in place?

they have no incentive to supply oil to just the highest-valued uses.

what does the the Great Matzo Ball Debate tell us about price ceilings?

they reduce quality

surge price

when a company or business charges a higher price