Supply and Demand: Price Controls (Ceilings and FloorsModule 8

Feb 2015

Government Controls

There is often a strong political demand for governments to intervene in markets

Price Controls-When a government intervenes to regular prices

These come in the form of an upper limit and a lower limit – known respectively as a price ceiling and a price floor.

We will assume markets are efficient before price controls are imposed.

Price Ceilings

Typically imposed during crises – war, shortages, etc.

When price ceilings are imposed that are below equilibrium, the supplier might choose to offer fewer goods

And the demand for that good would increase, creating a shortage

If the price ceiling is above equilibrium, it won’t have any effect

Inefficient allocation to consumers is when those who really need something, cannot get it, while those who don’t necessarily need it, do get it.

Wasted resources – inefficiency by people expending money, effort, and time to cope with the shortages caused by the price ceiling.

Price Ceilings

Inefficiently low quality – sellers offer low quality good at a low price even though buyers would prefer a higher quality at a higher price

Black Markets – a market in which goods or services are bought and sold illegally – either because it is illegal to sell them at all or because the prices charged are legally prohibited by a price ceiling

Problems:

A persistent shortage of a good

Inefficiency arising from this persistent shortage in the form of inefficiently low quantity, inefficient allocation of the good to consumers, resources wasted and inefficiently low quality of goods

Emergence of illegal, black market activity

Price Floors

Minimum wage – a floor or lowest limit on the price of labor

When price floors are imposed that are above equilibrium, the supplier might choose to offer more goods

And the demand for that good would decrease, creating a surplus

If the price ceiling is below equilibrium, it won’t have any effect

In the case of agricultural surpluses, the government picks up the surplus

At times, the government will pay farmers NOT to produce

For minimum wage, those workers may not be able to find employment because the employers don’t want to pay the additional wages

Price Floors

Inefficiently low quantity – because a price floor raises the price of a good, the supply demanded would decrease, and a seller may choose not to produce as much. This is the same effect on ceilings and floors – a decrease in quantity supplied

Inefficient allocation of sales among sellers – those who would be willing to sell the good at the lowest price are not always those who manage to sell it

Wasted resources – purchases of surplus by the government, wasted time and effort

Inefficiently high quality – sellers offer high-quality goods at a high price, even though buyers would prefer a lower quality at a lower price

Price Floors

Negative side effects:

A persistent surplus of goods

Inefficiency arising from the persistent surplus in the form of inefficiently low quantity, inefficient allocation of sales among sellers, wasted resources, and an inefficiently high level of quality offered by suppliers

Illegal activity – bribery, corruption of gov’t officials, working “under the table”

Review

Do Module 8 Questions

Review answers with teacher

Complete Units 1 and 2 in the AP Economics workbook

Using Barron’s workbook handouts, complete questions on pages 20-22, 34-37, 51-52, and 70

Using Krugman’s exercises, do comparative advantage and trade exercise

Breathe….You have until Wednesday to get everything done before class. But, you will be facing a test that day.