Price and Quality Controls
Price Controls
• Legal restrictions on how high or low a
market may go
• Price Ceilings is the maximum price
sellers are allowed to charge for a good
or service
• Price Floor is the minimum price buyers
are required to pay for a good or service
Price Ceilings
• Typically imposed during a crisis
because these events often lead to
sudden price increases that hurt many
people but benefit a few
• Ex. WWII – aluminum and steel in
demand for the war and price controls
were in place to avoid a few earning
large profits
• Ex. Oil embargo in 1973, rent controls
The Market for Apartments in the Absence of
Government Controls
Monthly rent (per apartment)
S
$1,400
1,300
1,200
1,100
1,000
E
900
800
700
600
0
D
Monthly rent
(per apartment)
$1,400
1,300
1,200
1,100
1,000
900
800
700
600
1.6 1.7 1.8 1.9 2.0 2.1 2.2 2.3 2.4
Quantity of apartments (millions)
Quantity of apartments
(millions)
Quantity
demanded
1.6
1.7
1.8
1.9
2.0
2.1
2.2
2.3
2.4
Quantity
supplied
2.4
2.3
2.2
2.1
2.0
1.9
1.8
1.7
1.6
The Effects of a Price Ceiling
Monthly rent
(per apartment)
S
$1,400
1,200
E
1,000
A
B
Price
ceiling
800
Housing shortage
of 400,000
apartments
caused by
price ceiling
600
0
1.6
1.8
2.0
D
2.2
2.4
Quantity of apartments (millions)
Effects of Price Ceilings
• Don’t always cause a shortage
• If a price ceiling is set above the
equilibrium price, it won’t have any
effect
• But sometimes price ceilings can
cause inefficiency
How Price Ceilings Cause Inefficiency
The effects of Rent Controls:
1. Reduces the quantity of apartments rented
below the efficient level
2. Leads to misallocation of apartments among
would-be renters
3. Leads to wasted time and effort as people
search for apartments
4. Leads to landlords maintaining apartments
in inefficiently low quality or conditions
How Price Ceilings Cause Inefficiency
• Rent controls reduce the number of
apartments supplied and they
reduce the number of apartment
rented
A Price Ceiling Causes Inefficiently Low
Quantity
Monthly rent (per apartment)
Deadweight
Loss is the loss$1,400
in total surplus
that occurs 1,200
whenever an
1,000
action or a
policy reduces 800
the quantity
transacted
600
below the
efficient market
0
equilibrium
quantity.
S
E
Price
ceiling
D
1.6
1.8
Quantity
supplied with
rent control
2.0
2.2
Quantity supplied
without rent control
2.4
Quantity of apartments (millions)
Deadweight Loss
• Key concept in economics
• Occurs whenever an action or a policy leads
to a reduction in the quantity transacted
below the efficient market equilibrium
quantity
• Deadweight loss is a loss to society – a
reduction in the total surplus, a loss in
surplus that accrues to no one as a gain
Price Ceilings Causing Inefficient
Allocation to Consumers
• 2.2 million people wanted to rent an apartment at
$800 month
• Only 1.8 million apartments are available
• Of the 2.2 million people,
– some want an apartment so bad they will pay anything
– Some are only willing to pay a low price and will wait for
one to be available
• An efficient allocation of apartments would reflect
these differences, one who wants one urgently will
get one and people who can wait will not get one
BUT….this does not happen
Inefficient Allocation to
Consumers
• Instead, in an inefficient distribution
of apartments, people who aren’t in
a hurry will get one and those who
are, won’t.
WHY????
Price Ceilings Causing Wasted
Resources
• Price ceilings typically lead to inefficiency in
of wasted resources
• People expend money, effort, and time to
cope with the shortages caused by the price
ceiling
• Ex. 1979, price controls on gasoline
– Lead to shortages that forced many to spend
hours each week waiting in lines and missing out
on wages and leisure time – opportunity cost
Price Ceilings Causing Goods to be
of Low Quality
• Sellers offer low-quality goods at a low
price even though buyers would rather
have higher quality and are willing to
pay for it
Price Ceilings Causing Illegal
Activities
• Price Ceilings can lead to goods being
bought and sold illegally
• Black Markets are a market in which
goods or services are bought and sold
illegally – either because it is illegal to
sell that at all or because the prices
charged are legally prohibited by a price
ceilings
Why are there Price Ceilings?
1. They do benefit some people
2. Buyers may not even know the goods
they are using/buying have price
controls
3. And (according to textbooks and
economists) government officials do
not understand supply and demand
analysis
Price Floors
• Government intervention to push
market prices up instead of down
• Minimum Wage is a legal floor on the
wage rate which is the price of labor
The Market for Butter in the Absence
of Government Controls
Quantity of butter
(millions of pounds)
Price of
butter
(per
pound)
Price of butter
(per pound)
S
$1.40
1.30
1.20
1.10
E
1.00
0.90
$1.40
$1.30
$1.20
$1.10
$1.00
$0.90
$0.80
$0.70
$0.60
0.80
0.70
0.60
D
0
6
7
8
9
10
11
12
13
14
Quantity of butter (millions of pounds)
Quantity
demanded
8.0
8.5
9.0
9.5
10.0
10.5
11.0
11.5
12.0
Quantity
supplied
14.0
13.0
12.0
11.0
10.0
9.0
8.0
7.0
6.0
The Effects of a Price Floor
Price of butter
(per pound)
Butter surplus of 3
million pounds caused
by price floor
$1.40
1.20
A
S
B
Price
floor
E
1.00
0.80
0.60
0
D
6
8
9
10
12
14
Quantity of butter (millions of pounds)
Effects of a Price Floor
• Price floors do not always lead to an
unwanted surplus
• Some price floors are irrelevant
• If a price floor is binding (permanent)
what happens to the unwanted surplus?
Price Floors Causes Low Quantity
• Price floors raise the price of a good to
consumers
• Price floors also reduce the quantity of that
good demanded – sellers can’t sell more
units of a good than buyers are willing to pay
• Price floors reduces the quantity of a good
bought and sold below the market
equilibrium quantity and leads to a
deadweight loss
A Price Floor Causes Inefficiently Low Quantity
Price of butter
(per pound)
S
$1.40
1.20
Deadweight
loss
Price
floor
E
1.00
0.80
0.60
0
D
6
8
9
Quantity
demanded with
price floor
10
12
Quantity
demanded
without price floor
14
Quantity of butter
(millions of pounds)
Price Floors Causes Inefficient
Allocation of Sales Among Sellers
• Price ceilings can lead to inefficient
allocation
• Price floors can cause inefficient
allocation of sales among sellers – those
who would be willing to sell the good at
the lowest price are not always those
who actually manage to sell it
Price Floors Cause Wasted
Resources
• Government purchasing of unwanted
surplus of agricultural products
• Surplus is destroyed or it is stored and
will go bad eventually
• Price floors also lead to wasted time and
effort
– Minimum wage jobs
Price Floors Cause Inefficiency in
the Quality of Goods Produced
• Sellers offer high-quality goods at a high
price, even though buyers would prefer
a low quality at a lower price
• People want quality but only if it is
worth the price
Price Floors Cause Illegal Activity
• Price floors cause incentives for illegal
activity
• Working off the books for employers
• Bribing Government Inspectors
Controlling Quantities
• Quantity control (quota) is an upper
limit on the quantity of some good that
can be bought or sold.
• Ex. Taxi Medallions
Controlling Quantities
• The total amount of the good than can
be transacted under the quantity
control is a quota limit
• Controlling quantity is done though a
license, an owner is given the right to
supply a good
The Market for Taxi Rides in the
Absence of Government Controls
Quantity of rides
(millions per year)
Fare
(per ride)
Fare
(per ride)
S
$7.00
6.50
6.00
5.50
E
5.00
4.50
4.00
3.50
3.00
Supply Price
– a given quantity is
the price at which producers will
supply that quantity
0
6
7
8
9
10
11
$7.00
Quantity
demanded
6
Quantity
supplied
14
$6.50
7
13
$6.00
8
12
$5.50
9
11
$5.00
10
10
$4.50
11
9
$4.00
12
8
$3.50
13
7
$3.00
14
6
D
12 13 14
Quantity of rides (millions per year)
Demand Price – a given quantity
is the price at which consumers
will demand that quantity
Controlling Quotas
• NYC limits the quantity of taxi rides to 8
million per year (assumption for
analysis)
• Medallions are available to selected
drivers for a total of 8 million rides
• Medallion holders can drive their own
taxi or rent their medallions to others
for a fee
Effect of a Quota on the Market for Taxi Rides
Quantity of rides
(millions per year)
Fare
(per
ride)
S
Deadweight
loss
$7.00
6.50
$7.00
A
6.00
5.50
5.00
The
“wedge”
E
4.50
4.00
B
3.50
3.00
D
Quota
0
6
7
8
9
10
11
12
Fare
(per ride)
13
14
Quantity of rides (millions per year)
Quantity
demanded
6
Quantity
supplied
14
$6.50
7
13
$6.00
8
12
$5.50
9
11
$5.00
10
10
$4.50
11
9
$4.00
12
8
$3.50
13
7
$3.00
14
6
Controlling Quotas
• How can the price received (quantity
supplied) be different from the price paid
(quantity demanded)?
• Two transactions and thus two prices
1. The transactions in taxi rides and the price
at which these occur
2. The transaction of medallions and the price
at which these occur
Controlling Quotas
• In every case at which the supply of goods is legally
resticted there is a wedge
• A wedge between the
demand price of the quantity
transacted and the supply price
of the quantity transacted
• This line represents the
quota rent which 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 license are
traded
Quantity Controls Side Effects
1. Deadweight loss because some
mutually beneficial transactions don’t
occur
2. Incentives for illegal activities
Price and Quality Controls
Notes
Price Controls
• Legal restrictions on how high or low a
market may go
• Price Ceilings is
• Price Floor is
Price Ceilings
• Typically imposed during a crisis
because these events often lead to
sudden price increases that hurt many
people but benefit a few
The Market for Apartments in the Absence of
Government Controls
Monthly rent (per apartment)
S
$1,400
1,300
1,200
1,100
1,000
E
900
800
700
600
0
D
Monthly rent
(per apartment)
$1,400
1,300
1,200
1,100
1,000
900
800
700
600
1.6 1.7 1.8 1.9 2.0 2.1 2.2 2.3 2.4
Quantity of apartments (millions)
Quantity of apartments
(millions)
Quantity
demanded
1.6
1.7
1.8
1.9
2.0
2.1
2.2
2.3
2.4
Quantity
supplied
2.4
2.3
2.2
2.1
2.0
1.9
1.8
1.7
1.6
The Effects of a Price Ceiling
Monthly rent
(per apartment)
S
$1,400
1,200
E
1,000
A
B
Price
ceiling
800
600
0
D
1.6
1.8
2.0
2.2
2.4
Quantity of apartments (millions)
Effects of Price Ceilings
• Don’t always cause a shortage
• If a price ceiling is set above the
equilibrium price, it won’t have any
effect
• But sometimes price ceilings can
cause _________________
How Price Ceilings Cause Inefficiency
The effects of Rent Controls:
1. Reduces the quantity of apartments rented
below the efficient level
2. Leads to misallocation of apartments among
would-be renters
3. Leads to wasted time and effort as people
search for apartments
4. Leads to landlords maintaining apartments
in inefficiently low quality or conditions
How Price Ceilings Cause Inefficiency
• Rent controls reduce the number of
apartments supplied and they
reduce the number of apartment
rented
A Price Ceiling Causes Inefficiently Low
Quantity
Monthly rent (per apartment)
Deadweight
Loss is
S
$1,400
1,200
E
1,000
Price
ceiling
800
600
0
D
1.6
1.8
Quantity
supplied with
rent control
2.0
2.2
Quantity supplied
without rent control
2.4
Quantity of apartments (millions)
Deadweight Loss
• Key concept in economics
• Occurs whenever an action or a policy leads
to a reduction in the quantity transacted
below the efficient market equilibrium
quantity
• Deadweight loss is a loss to society –
Price Ceilings Causing Inefficient
Allocation to Consumers
• 2.2 million people wanted to rent an apartment at
$800 month
• Only 1.8 million apartments are available
• Of the 2.2 million people,
• An efficient allocation of apartments would reflect
these differences, one who wants one urgently will
get one and people who can wait will not get one
BUT….this does not happen
Inefficient Allocation to
Consumers
• Instead, in an inefficient distribution
of apartments, people who aren’t in
a hurry will get one and those who
are, won’t.
WHY????
Price Ceilings Causing Wasted
Resources
• Price ceilings typically lead to inefficiency in
of wasted resources
• People expend money, effort, and time to
cope with the shortages caused by the price
ceiling
Price Ceilings Causing Goods to be
of Low Quality
Price Ceilings Causing Illegal
Activities
• Price Ceilings can lead to goods being
bought and sold illegally
• Black Markets are
Why are there Price Ceilings?
1. They do benefit some people
2. Buyers may not even know the goods
they are using/buying have price
controls
3. And (according to textbooks and
economists) government officials do
not understand supply and demand
analysis
Price Floors
• Government intervention to push
market prices up instead of down
The Market for Butter in the Absence
of Government Controls
Quantity of butter
(millions of pounds)
Price of
butter
(per
pound)
Price of butter
(per pound)
S
$1.40
1.30
1.20
1.10
E
1.00
0.90
$1.40
$1.30
$1.20
$1.10
$1.00
$0.90
$0.80
$0.70
$0.60
0.80
0.70
0.60
D
0
6
7
8
9
10
11
12
13
14
Quantity of butter (millions of pounds)
Quantity
demanded
8.0
8.5
9.0
9.5
10.0
10.5
11.0
11.5
12.0
Quantity
supplied
14.0
13.0
12.0
11.0
10.0
9.0
8.0
7.0
6.0
The Effects of a Price Floor
Price of butter
(per pound)
S
$1.40
1.20
A
B
Price
floor
E
1.00
0.80
0.60
0
D
6
8
9
10
12
14
Quantity of butter (millions of pounds)
Effects of a Price Floor
• Price floors do not always lead to an
unwanted surplus
• Some price floors are irrelevant
• If a price floor is binding (permanent)
what happens to the unwanted surplus?
Price Floors Causes Low Quantity
• Price floors raise the price of a good to
consumers
• Price floors also reduce the quantity of that
good demanded – sellers can’t sell more
units of a good than buyers are willing to pay
• Price floors reduces the quantity of a good
bought and sold below the market
equilibrium quantity and leads to a
deadweight loss
A Price Floor Causes Inefficiently Low Quantity
Price of butter
(per pound)
S
$1.40
1.20
Deadweight
loss
Price
floor
E
1.00
0.80
0.60
0
D
6
8
9
Quantity
demanded with
price floor
10
12
Quantity
demanded
without price floor
14
Quantity of butter
(millions of pounds)
Price Floors Causes Inefficient
Allocation of Sales Among Sellers
• Price ceilings can lead to inefficient
allocation
• Price floors can cause inefficient
allocation of sales among sellers
Price Floors Cause Wasted
Resources
• Government purchasing of unwanted
surplus of agricultural products
• Surplus is destroyed or it is stored and
will go bad eventually
• Price floors also lead to wasted time and
effort
Price Floors Cause Inefficiency in
the Quality of Goods Produced
• Sellers offer high-quality goods at a high
price, even though buyers would prefer
a low quality at a lower price
Price Floors Cause Illegal Activity
• Price floors cause incentives for illegal
activity
Review:
• The state legislature mandates a price
floor for gasoline of Pf per gallon.
Assess the following statements and
illustrate your answer using the figure
provided.
a. Proponents of the law claim it will increase the
income of gas station owners. Opponents claim it
will hurt gas station owners because they will lose
customers.
b. Proponents claim consumers will be better off
because gas stations will provide better service.
Opponents claim consumers will be generally
worse off because they prefer to buy gas at
cheaper prices.
c. Proponents claim that they are helping gas station
owners without hurting anyone else. Opponents
claim that consumers are hurt and will end up
doing things like buying gas in a nearby state or on
the black market.
Controlling Quantities
• Quantity control (quota) is an upper
limit on the quantity of some good that
can be bought or sold.
Controlling Quantities
• The total amount of the good than can
be transacted under the quantity
control is a quota limit
• Controlling quantity is done though a
license, an owner is given the right to
supply a good
The Market for Taxi Rides in the
Absence of Government Controls
Quantity of rides
(millions per year)
Fare
(per ride)
Fare
(per ride)
S
$7.00
6.50
6.00
5.50
E
5.00
4.50
4.00
3.50
3.00
0
D
6
7
8
9
10
11
12 13 14
Quantity of rides (millions per year)
$7.00
Quantity
demanded
6
Quantity
supplied
14
$6.50
7
13
$6.00
8
12
$5.50
9
11
$5.00
10
10
$4.50
11
9
$4.00
12
8
$3.50
13
7
$3.00
14
6
Controlling Quotas
• NYC limits the quantity of taxi rides to 8
million per year
• Medallions are available to selected
drivers for a total of 8 million rides
• Medallion holders can drive their own
taxi or rent their medallions to others
for a fee
Effect of a Quota on the Market for Taxi Rides
Quantity of rides
(millions per year)
Fare
(per
ride)
S
Deadweight
loss
$7.00
6.50
$7.00
A
6.00
5.50
5.00
The
“wedge”
E
4.50
4.00
B
3.50
3.00
D
Quota
0
6
7
8
9
10
11
12
Fare
(per ride)
13
14
Quantity of rides (millions per year)
Quantity
demanded
6
Quantity
supplied
14
$6.50
7
13
$6.00
8
12
$5.50
9
11
$5.00
10
10
$4.50
11
9
$4.00
12
8
$3.50
13
7
$3.00
14
6
Controlling Quotas
• How can the price received (quantity
supplied) be different from the price paid
(quantity demanded)?
• Two transactions and thus two prices
Controlling Quotas
• In every case at which the supply of goods is legally
restricted there is a wedge
• A wedge between the
demand price of the quantity
transacted and the supply price
of the quantity transacted
• This line represents the
quota rent which 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 license are
traded
Quantity Controls Side Effects