Econ 101 Chapter 8

Binding price floor effect on equilibrium

Surplus, higher supply created by higher price, but resulting in a lower quantity demanded.

Non-binding price ceiling effect on equilibrium

Surplus, same price, same quantity.

Price Floor

The legal minimum price that can be charged in a market

A binding price floor...

1. Leads to wasteful production 2. leads to unrealized gains from trade (DWL) 3. leads to wasteful increases in product quality

A binding price ceiling...

1. Reduces product quality 2. Creates wasteful lines and other search costs 3. Leads to unrealized gains from trade i.e., DWL

Binding price floor

A binding price floor is set above the equilibrium price. It is binding because it requires the equilibrium to shift and resources to be allocated differently

Price Cieling

A legal maximum price that can be charged within a market.

Non-binding price floor

A non-binding price floor is set below the equilibrium price. This changes nothing because at this price there is a shortage, which drives prices up. Nothing is preventing prices from rising, so nothing will change.

Competition with a price floor in place

Because airplane companies could not compete by lowering prices, they offered higher quality flying experiences, a wasteful allocation of resources because consumers would rather have a cheaper flight than a luxurious flying experience.

A binding price floor leads to wasteful production

Because the price is set higher, suppliers will be willing and able to produce more goods. However, demand will go down as a result of the increase in price, meaning there is a wasteful surplus.

A binding price ceiling creates wasteful lines

Because there is a shortage only a percentage of people will be able to buy the product. This means people will be in lines waiting for their chance to purchase the product, meaning the opportunity cost of their time is a factor.

A binding price floor leads to unrealized gains from trade (DWL)

By cutting out the market of suppliers with lower marginal costs and the people who demand products at those lower costs the price floor leads to unrealized gains from trade.

Consumer Surplus and price floors

Consumer surplus decreases by the increase in price and the decrease in quantity demanded

Consumer Surplus and price ceilings

Consumer surplus increases by the reduction in price, and decreases by the reduction in quantity supplied.

Do lowest cost producers sell the good with a binding price floor?

No, because now there is twice as much suppliers willing to sell goods at the higher price, there is no guarantee that the producer with a lower marginal cost will be able to sell their product over a producer with a higher marginal cost.

Do buyers who value the good most consume the good with a binding price ceiling?

No. Only a percentage of the buyers will be able to get the good, and can't compete by raising prices.

Producer surplus and price ceilings

Producer surplus decreases by the reduction in price and quantity supplied.

Producer surplus and price floors

Producer surplus increases by the increase in price, and decreases by the DWL

Allocation of goods with binding price ceiling

Shortage means a higher quantity is demanded than is supplied, but prices cannot be driven higher. -People waiting in lines -Luck or who you know, some other deciding factor

Non-binding price floor effect on equilibrium

Shortage, no change in price, no change in quantity demanded.

Binding price ceiling effect on equilibrium

Shortage: lower price creates higher quantity demanded and lower quantity supplied

A binding price ceiling leads to unrealized gains from trade (I.E. DWL)

The suppliers who have a slightly higher marginal cost and the consumers willing to pay for their product are cut out of the market, resulting in unrealized gains from trade.

A binding price ceiling reduces product quality

To save money suppliers will reduce the quality of the product, since they can't make money by increasing prices to allow for the rise in demand

Total surplus and price ceilings

Total surplus decreases by the amount of DWL created by the price ceiling, the reduction in consumer and producer surplus caused by the reduction in quantity reduced.

Total Surplus and price floors

Total surplus is reduced by the DWL created by the increase in price.

Non-binding price ceiling

When the price ceiling is set above equilibrium it makes no changes, since at this point there is a surplus, driving prices down.

Binding price ceiling

When the price ceiling is set below equilibrium it is binding. At this point it is changing the equilibrium and the allocation of resources.

Do buyers who value the good most consume the good with a binding price floor?

Yes, because now the price floor prevents those who don't value the good as much from participating in the market.

Do the lowest cost producers sell the good with a binding price ceiling?

Yes. Since they cannot make money increasing prices, suppliers will reduce the quality of the product to sell more and save money.