Price Ceiling Effects

5 Key excerpts on "Price Ceiling Effects"

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  eBook - ePub

  Foundations of Economics

  A Christian View

  • Ritenour(Author)
  • 2010(Publication Date)
  • Wipf and Stock

    (Publisher)

  ineffective . Typically, those words are taken to mean that something either works well or does not. In our case, however, the terms refer to whether the price ceiling has an effect on the actual price that buyers pay and sellers receive in an exchange. An effective price ceiling hampers voluntary exchange from negotiating a market price. An ineffective price ceiling is one that has no effect on the price that is charged and received in the market.

  A price ceiling is effective if the maximum legal price is less than the market price. An effective price ceiling is illustrated in the graph in figure 15.1. Figure 15.1. An effective price ceiling is a maximum legal price fixed below the market price. It always results in a shortage.

  As can be seen, if the government enacts a price ceiling P C that is below the market price P Mkt the market will not clear. We know this by identifying the quantity demanded and supplied at the ceiling price. Remember that the demand curve tells us the maximum quantity buyers will buy at any given price. Consequently, if we trace a horizontal line from the price axis at P C to the demand curve, we see that the quantity demanded is Q D . Likewise, the supply curve tells us the maximum quantity sellers are willing to sell at any given price. If we follow the same horizontal price line to the supply curve, we see that the quantity supplied at the price ceiling is Q S . We can determine the state of the market by comparing the quantity supplied with the quantity demanded.

  Because the price ceiling is below the market clearing price, the quantity demanded is greater than the quantity supplied. Chapter 5, in dealing with price determination, illustrated that this is a case of excess demand. Excess demand results in frustrated buyers because there are some buyers who are willing to buy the good at that price but cannot because there is not enough supplied by sellers. In a free market, this excess demand withers away as the more eager buyers bid up the price until everyone who wants to buy can buy. This occurs at the market price, the price at which quantity supplied equals quantity demanded.

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  eBook - PDF

  Macroeconomics for Today

  • Irvin B. Tucker, Irvin Tucker(Authors)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  In other markets, the government ’ s goal is to intervene and maintain a price higher than the equilibrium price. Market supply and demand anal-ysis is a valuable tool for understanding what happens when the government fixes prices. There are two types of price controls: price ceilings and price floors . EXHIBIT 3 Effect of Shifts in Demand or Supply on Market Equilibrium Change Effect on equilibrium price Effect on equilibrium quantity Demand increases Increases Increases Demand decreases Decreases Decreases Supply increases Decreases Increases Supply decreases Increases Decreases CHAPTER 4 | Markets in Action 103 Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 4-2a PRICE CEILINGS Case 1: Rent Controls What happens if the government prevents the price system from setting a market price “ too high ” by mandating a price ceiling ? A price ceiling is a legally established maximum price a seller can charge. Rent controls are an example of the imposition of a price ceiling in the market for rental units. New York City, Washington, D.C., Los Angeles, San Francisco, and other communities in the United States have some form of rent control. Since World War I, rent controls have been widely used in Europe. The rationale for rent controls is to provide an “ essential service ” that would otherwise be unaffordable by many people at the equilibrium rental price. Let ’ s see why most economists believe that rent controls are counterproductive. Exhibit 5 is a supply and demand diagram for the quantity of rental units demanded and supplied per month in a hypothetical city.

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  eBook - ePub

  Microeconomics in Context

  • Neva Goodwin, Jonathan M. Harris, Julie A. Nelson, Pratistha Joshi Rajkarnikar, Brian Roach, Mariano Torras(Authors)
  • 2022(Publication Date)
  • Routledge

    (Publisher)

  But in other cases, especially where the elasticity of supply is high, price controls can be disastrous. One example is in Zimbabwe, where extensive price controls were imposed in 2007 with the goal of keeping prices for food and other essential goods low. As our example leads us to expect, the result of enforced low prices was to destroy the incentive for farmers and other suppliers to produce, leading to severe shortages. So, the poor people whom the policy was supposed to help were instead hurt by the unavailability of food and other basic goods. Meanwhile, farmers and other merchants were forced into bankruptcy. The price controls had to be abandoned after they forced the economy into virtual collapse.

  4.3 Price Floors

  Governments also sometimes intervene in markets with the opposite goal—to keep prices from falling to the market equilibrium. A price set above the market price is called a price floor or “price support” (because it establishes a minimum allowable price).

  price floor: a regulation that specifies a minimum price for a particular product

  Why would governments want to keep prices at higher levels? The obvious reason is to aid producers. Governments commonly specify minimum prices for agricultural products such as grain or milk. The goal is to help farmers, who often have considerable political influence. Of course, this also pushes up prices to consumers.

  The economic effect is the opposite of a price ceiling. Rather than creating a shortage, price floors tend to create a surplus, as producers increase their output to take advantage of profitable higher prices. But these higher prices cause consumers to cut back their purchases. In some cases, the government will buy up the surplus created by the price floor. From an economic point of view, this is clearly inefficient, because it encourages excess production and involves both higher prices to consumers and large government expenditures. Generally, economists would recommend a more efficient approach of giving direct aid to farmers, if this were considered necessary, but leaving market prices alone.

  Another classic example of a price floor is the minimum wage. Most governments have minimum wage laws specifying that hourly wages must be at least a given level. The United States has a federal minimum wage of $7.25 per hour (as of 2022), although about 30 states have set higher minimum wage rates. Most other developed countries have higher minimum wage rates. For example, the minimum wage is equivalent to about $10 per hour in Canada, about $11 per hour in France, and $15 per hour in Australia.6

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  eBook - PDF

  Principles of Macroeconomics

  • Steven A. Greenlaw, Timothy Taylor(Authors)
  • 2014(Publication Date)
  • Openstax

    (Publisher)

  But there is an additional twist here. Along with creating inefficiency, price floors and ceilings will also transfer some consumer surplus to producers, or some producer surplus to consumers. Imagine that several firms develop a promising but expensive new drug for treating back pain. If this therapy is left to the market, the equilibrium price will be $600 per month and 20,000 people will use the drug, as shown in Figure 3.24 (a). The original level of consumer surplus is T + U and producer surplus is V + W + X. However, the government decides to impose a price ceiling of $400 to make the drug more affordable. At this price ceiling, firms in the market now produce only 15,000. As a result, two changes occur. First, an inefficient outcome occurs and the total surplus of society is reduced. The loss in social surplus that occurs when the economy produces at an inefficient quantity is called deadweight loss. In a very real sense, it is like money thrown away that benefits no one. In Figure 3.24 (a), the deadweight loss is the area U + W. When deadweight loss exists, it is possible for both consumer and producer surplus to be higher, in this case because the price control is blocking some suppliers and demanders from transactions they would both be willing to make. Chapter 3 | Demand and Supply 69 A second change from the price ceiling is that some of the producer surplus is transferred to consumers. After the price ceiling is imposed, the new consumer surplus is T + V, while the new producer surplus is X. In other words, the price ceiling transfers the area of surplus (V) from producers to consumers. Note that the gain to consumers is less than the loss to producers, which is just another way of seeing the deadweight loss. Figure 3.24 Efficiency and Price Floors and Ceilings (a) The original equilibrium price is $600 with a quantity of 20,000. Consumer surplus is T + U, and producer surplus is V + W + X.

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  eBook - PDF

  Essentials of Economics

  • James D Gwartney, Richard Stroup, J. R. Clark(Authors)
  • 2014(Publication Date)
  • Academic Press

    (Publisher)

  Shortage: A condition in which the amount of a good offered by sellers is less than the amount demanded by buy-ers at the existing price. An increase in price would elimi-nate the shortage. Price Floor: A legally estab-lished minimum price that buyers must pay for a good or resource. Surplus: A condition in which die amount of a good that sellers are willing to offer is greater than the amount diat buyers will purchase at the existing price. A decline in price would eliminate the surplus. Buyers often believe that prices are too high, and sellers generally perceive prices as too low. Unhappy with the prices established by market forces, individuals sometimes attempt to have prices set by legislative action. Fixing prices seems like a simple, straightforward solution. Simple, straightforward solutions, how-ever, often have unanticipated repercussions. Do not forget the secondary effects. Price ceilings are often popular during a period of inflation, a situation in which prices of most products are continually rising. Many people mistakenly believe that the rising prices are the cause of the inflation rather than just one of its effects. Exhibit 10a illustrates the impact of fixing a price of a product below its equilibrium level. Of course, the price ceiling does result in a lower price than would result from market forces, at least in the short run. However, that is not the end of the story. At the below-equilibrium price, producers will be unwilling to supply as much as consumers would like to purchase. A shortage (Q, — (7> Exhibit 10a) of the goods will result. A shortage is a situation in which the quantity demanded by consumers exceeds the quantity supplied by producers at the existing price. Unfortunately, fixing the price will not eliminate the rationing problem. Nonprice factors will now become more important in the rationing process. Producers will be more discriminating in their sales to eager buyers.

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