Price & Quantity Controls
Purpose of Controls
Even when a market is efficient, governments
often intervene to pursue greater fairness or to
please a powerful interest group. Interventions
can take the place of price controls, or quantity
controls.
I. Price controls
Price controls-when government intervenes to
control price. Two types:
• price ceiling-a maximum price sellers are
allowed to charge for a good or service, or an
upper limit.
• price floor-a minimum price buyers are
required to pay for a good or service, or a
lower limit
A. Price ceilings
• Typically imposed during crises-”price
gouging” for example. During WWII, the US
govt imposed many price ceilings on goods.
• There are few govt price ceilings today. Rent
control in NYC is one example.
Yadayadayadaecon
Effects of a price ceiling:
To be effective (binding) , price ceilings must be set
below Pe.
Price per taco
Q of tacos demanded
Q of tacos supplied
$1
9
1
$3
7
3
$4
6
4
$5
5
5
$7
3
7
$9
1
9
Equilibrium: Qe = 5, Pe=$ 5
Consumers are enraged at this high price and successfully
lobby for a law that says you can’t sell tacos for more than
$3. This is good, right?
1. Shortage-where Qd >Qs
Price per taco
Q of tacos demanded
Q of tacos supplied
$1
9
1
$3
7
3
$4
6
4
$5
5
5
$7
3
7
$9
1
9
If Pc is $3, Qd = 7 & Qs = 3. Therefore, there is a
shortage of 4. Too few of a good will be
available.
2. Market Inefficiencies
Governmental price controls often lead to
inefficiencies-lost opportunities for both buyers
and sellers.
Deadweight loss is the lost gains associated with
transactions that do not occur due to market
intervention.
a. Inefficient allocation to consumers
People who want the good badly and are willing
to pay a high price don’t get it, and those who
care relatively little about the good are only
willing to pay a relatively low price to get it.
A market is inefficient if there are missed
opportunities.
b. Wasted Resources
People expend money, effort, and time to cope
with the shortages caused by the price ceiling.
Price controls often create missed opportunities
where consumers could better use their time/
money if there was efficiency.
c. Inefficiently low quality
Sellers offer low-quality goods at a low price
even though buyers and sellers would rather
have a higher quality and pay for it.
Sellers have no incentive to provide a better
product bc they cannot raise prices but are able
to find consumers easily.
d. Black markets
A black market is one in which goods or services
are bought and sold illegally.
Summary
Price ceilings are enacted because
1. They do benefit some consumers. Consumers
may have the political clout to persuade
government that the equilibrium price is taking
advantage of them.
2. When they have been in effect for a long time,
buyers may not have a realistic idea of what
would happen without them.
3. Government officials often do not understand
supply and demand analysis.
B. Price Floors
When governments intervene to push prices up
instead of down. Typically legislated for
agricultural products in the US. Most common
price floor is the minimum wage.
Effects of a price floor
If Pe is considered “too low,” a price floor is set above the
equilibrium price. A price floor set below the equilibrium
price has no effect.
Equilibrium: Qe = 5, Pe =$5
Producers are enraged at this low price and successfully
lobby for a law that says you can’t sell tacos for less than
$7.
This is good for sellers, right?
1. Surplus-where Qs >Qd
Binding price floors lead to excess supply.
At Pf=$7, Qs= 7, Qd = 3, so there is a surplus of 4
tacos. Too much of a good will be available.
2. Market Inefficiencies
Governmental price controls often lead to
inefficiencies-lost opportunities for both buyers
and sellers.
Deadweight loss is the lost gains associated with
transactions that do not occur due to market
intervention.
a. Inefficiently low quantity- Since a price floor raises
the price of a good to consumers, quantity demanded
falls, so the quantity bought and sold falls.
b. 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.
c. Wasted resources-to combat surpluses,
sometimes governments buy unwanted goods.
Sometimes, these goods go unused and are
destroyed.
d. Inefficiently high quality-Sellers offer highquality goods at a high price, even though
buyers would prefer a lower quality at a lower
price.
summary
So why are there price floors?
• Legislators believe the relevant market is unfair
• Legislators are influenced by powerful sellers
• Legislators may not understand the supply and
demand model
Quantity Controls
A quantity control, or quota is an upper limit on
the amount of a good able to be sold.
Governments often control quantities through
the issuance of licenses.
Why quotas?
• To combat potential shortages(agricultural
quotas)
• Environmental concerns (hunting/ fishing
quotas; limits on autos/ taxis)
• To maintain price levels (OPEC’s limit on crude
oil)
• The demand price of a given quantity is the
price at which consumers will demand that
quantity.
• The supply price of a given quantity is the
price at which producers will supply that
quantity.
S
Pd
Pe
Ps
D
Qq
Qe
•
•
•
•
Pe; Qe= equilibrium
Qq= quantity quota
Ps= supply price
Pd= demand price
Quotas are only effective if
they are set below
equilibrium quantity
• A quota drives a wedge between what the
demand price and the supply price of a good.
• This wedge is also called the quota rent which
represents the earnings that accrue to the
holder of a license.
Wedge=a +b on graph
consumer & producer surplus
Consumer surplus is the difference between the total
amount that consumers are willing and able to pay for
a good or service and the total amount that they
actually pay. ($ left over)
Producer surplus is the difference between what
producers are willing and able to supply a good for and
the price they actually receive. (excess profit)
Effects of quotas
1.Deadweight loss-inefficiency resulting from
lost opportunities. Prevents some mutually
beneficial transactions from occurring.
Quantity Controls
Effect of a Quota on the Market for Taxi Rides
$7.00
Fare 6.50
(per
6.00
ride)
5.50
Deadweight
loss
S
Fare
(per ride)
A
The
wedge
Quantity of rides
(millions per year)
Quantity
demanded
Quantity
supplied
6
14
5.00
$7.00
$6.50
7
13
4.50
$6.00
8
12
$5.50
9
11
3.50
$5.00
10
10
3.00
$4.50
11
9
$4.00
12
8
$3.50
13
7
$3.00
14
6
E
4.00
B
D
Quota
0
6
7
8
9
10
11
12
13
14
Quantity of rides (millions per year)
Effects of quotas, cont.
3. Illegal activities-quantity controls provide an
incentive for people to break the law.
Ex., take bribes, poaching, working “off the
books,” etc.