AP Economics
University High
2012-2013
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In a competitive market, price will adjust
until quantity supplied equals quantity
demanded.
However, sometimes government feels
the need to intervene in the market and
prevent equilibrium from being reached
 Usually done with good intentions in
mind
 However, interventions result in
undesired secondary effects
Interventions usually in the form of price
floors or price ceilings
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Marginal buyers: Individuals on demand
curve that are not willing/able to pay market
price
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Marginal suppliers: Firms on supply curve not
willing/able to supply at market price
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“Pareto Optimum”
 Optimal level of tradeoff
 Not going to get more surplus
 Maximizing Efficiency
 What happens when you disturb pareto optimum?
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Price Ceiling: A legal maximum on the price at
which the good can be sold
 Below the equilibrium price if binding
▪ Significant effect
 Above the equilibrium price if non-binding
▪ No measurable effect
 Which side appears happier?
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Some other form of rationing mechanism has to
step in when price is unable to regulate market
 The true price of gasoline, which included both the cash
paid and the time spent waiting in line, was often higher
than it would have been if the price had not been
controlled.
 In 1979 the United States fixed the price of gasoline at
about $1.00 per gallon.
 If the market price had been $1.20, a driver who bought
ten gallons would apparently have saved $.20 per gallon,
or $2.00.
 But if the driver had to wait in line for thirty minutes to
buy gasoline, and if her time was worth $8.00 per hour,
the real cost to her was $10.00 for the gas and $4.00 for
the time, an overall cost of $1.40 per gallon.
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Sets a legal minimum price for a good or service
 Binding if ______the equilibrium
 Implemented to help ________
 Provides suppliers with a price _______than the original
market equilibrium
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Price floors, set above the equilibrium price, result in a ____ in
the market
 Surplus – Quantity supplied exceeds quantity demanded
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Decision to intervene in the market is a normative decision
 Why?
 Because policy makers are making decisions based on value
judgments
▪ Is the benefit to those receiving a higher wage greater than the
added cost to society?
▪ Is the benefit of having excess food production greater than the
additional costs that are incurred due to the market intervention?
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A common price floor is the implementation of a minimum wage
Labor market
 Firms demand labor
 Workers supply labor
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If market equilibrium set above equilibrium price for labor,
some of those not able to work at original equilibrium price
are now willing to supply labor at higher wage
 Increase in quantity of labor supplied
 Firms must pay more for labor and thus reduce the quantity of
labor demanded
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The result is a surplus of labor at new price (minimum wage
rate)
 Price is no longer the rationing mechanism in market
 Individuals willing and able to work at or below the minimum
wage rate might not be able to get a job