CHAPTER
8
DYNAMIC P OWERP OINT™ S LIDES BY S OLINA L INDAHL
Price Ceilings and Floors
CHAPTER OUTLINE
Price Ceilings
Rent Control (Optional Section)
Arguments for Price Controls
Universal Price Controls
Price Floors
For applications, click here
To Try it!
questions
To
Video
Food for Thought….
Some good blogs and other sites to get the juices flowing:
SEE THE INVISIBLE HAND
Iraq 2003: Gas prices are frozen at $.05 per gallon.
A good idea?
SEE THE INVISIBLE HAND
Getting in the way of the invisible hand?
Distorted price signals cause resources to be misallocated.
Price Ceilings
Policy makers may respond to buyers’
complaints that prices are “too high”
by enacting price controls.
A Price Ceiling is a maximum price allowed
by law.
Price ceilings limit the price sellers can charge
for their goods to the maximum price.
Prices cannot legally go higher than the
ceiling.
BACK TO
Price Ceilings
Price ceilings that involve a
maximum price below the market
price create five important effects.
1. Shortages
2. Reduction in Product Quality
3. Wasteful Lines and Other Costs of
Search
4. Loss of Gains from Trade
5. Misallocation of Resources
BACK TO
Shortages
1. When prices are held below the market price
shortages are created.
The shortage = difference between the Qd and
the Qs at the controlled price.
The lower the controlled price relative to the
market equilibrium price, the larger the shortage.
BACK TO
Shortages
Price Ceilings Create Shortages
Price
Supply
Market Equilibrium
Shortage
Controlled
Price
(Ceiling)
Demand
Quantity
Qsupplied at the
Controlled
Price
Qdemanded at the
Controlled Price
BACK TO
SEE THE INVISIBLE HAND
A shortage of vinyl in 1973 forced Capitol
Records to melt down slow sellers so they
could keep pressing Beatles’ albums.
Take a look…..
Why do you think farmers killed a million baby chickens in 1973?
Does it matter that chicken prices were subject to a price ceiling but
their feed was not? Click on the picture for a short video (first 1:40 min of
the clip)
http://www.youtube.com/watch?v=IFbAwzU6G7s&NR=1
To next
Video
Reduction of Product Quality
2. At the controlled price, sellers have
more customers than goods.
In a free market, this would be an opportunity
to profit by raising prices.
But when prices are controlled, sellers cannot.
Sellers respond to this problem in two ways:
Reduce quality
Reduce service
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Wasteful Lines and Other
Costs of Search
3. Price controls that create
shortages lead to bribery and
wasteful lines.
Shortages: not all buyers will be able
to purchase the good.
Normally, buyers would compete
with each other by offering a higher
price.
If price is not allowed to rise, buyers
must compete in other ways.
BACK TO
Take a look…..
How do rent-controlled apartments get distributed?
Click on the picture below to find out in this clip from
the “Economics of Seinfeld”. (1:20 minutes)
http://yadayadayadaecon.com/clip/6/
BACK TO
Wasteful Lines and Other
Costs of Search
Some buyers may be willing to bribe
sellers in order to obtain the good.
The highest bribe a buyer would pay is the
difference between his max price and the
price ceiling.
If bribes are common, then the total price of
the good is the legal price plus the bribe.
BACK TO
Wasteful Lines and Other
Costs of Search
Buyers can also compete with each other
through their willingness to wait in line.
The maximum wait time (translated into
monetary terms) for a buyer is the difference
between the max price and the price ceiling.
So the total price of the good is the legal price
plus the time costs.
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Wasteful Lines and Other
Costs of Search
Bribes and waits both lead to a total price
that is greater than the controlled price,
(but they are different.)
Bribes involve a simple transfer from buyers to
sellers.
The time spent waiting in line, however, is
simply lost – paying in time is much more
wasteful.
BACK TO
Wasteful Lines and Other
Costs of Search
Price Ceilings Create Wasteful Lines
Price
Supply
Total Value
of Wasted
Time
Time Cost
Willingness to
Pay
Market Equilibrium
Shortage
Controlled
Price (Ceiling)
Demand
Quantity
Qsupplied at the
Controlled Price
Qdemanded at the
Controlled Price
BACK TO
Lost Gains from Trade
4. Price controls reduce the gains from
trade.
Price ceilings set below the market price
cause Qs to be less than the market Q.
When Q is below the equilibrium market Q,
consumers value the good more than
the cost of its production.
This represents a gain from trade that would
be exploited (if the market were free).
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Lost Gains from Trade
Dead-weight Loss is the total of lost
consumer and producer surplus when
all mutually profitable gains from
trade are not exploited.
Price ceilings create a dead-weight loss
by forcing Qs below the market Q.
Buyers and sellers would both benefit from
trade at a higher price, but cannot since it is
illegal for price to rise.
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Lost Gains from Trade
Price Ceilings Reduce the Gains from Trade
Consumer Surplus Shrinks to this
Price
Producer Surplus Shrinks to this
Willingness to
Pay
Market
Price
Supply
Consumer
surplus in
market
equilibrium
Market Equilibrium
Producer Surplus in
equilibrium
Controlled
Price
(Ceiling)
Shortage
Demand
Quantity
Qsupplied
Qmarket
Qdemanded
BACK TO
Lost Gains from Trade
Price Ceilings Reduce the Gains from Trade
Deadweight Loss (lost gains
Price
from trade)
= Lost Consumer Surplus
+ Lost Producer Surplus
Supply
Willingness to
Pay
Market
Price
Controlled
Price
(Ceiling)
Total
Value of
Wasted
Time
Lost
Consumer
Surplus
Market Equilibrium
Lost
Producer
Surplus
Shortage
Demand
Quantity
Qsupplied
Qmarket
Qdemanded
BACK TO
Misallocation of Resources
5. Price controls distort signals and
eliminate incentives-- leading to a
misallocation of resources.
Consumers who value a good most are
prevented from signaling their preference (by
offering sellers a higher price.)
So producers have no incentive to supply the
good to the “right” people first.
As a result, goods are misallocated.
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Misallocation of Resources
Price Controls Prevent Resources from flowing to their Highest-Valued Uses
BACK TO
Rent Controls
Rent Control: a regulation that prevents
rents from rising to equilibrium levels.
Rent control is a price ceiling whose
effects worsen over time No one wants to build new
apartments if the rents will be
artificially low…
BACK TO
Rent Control
•Example: San Francisco
•Very hot home sales/rental market
•Average rent close to $3000/month,
highest in the country
•Sustained by high tech workers who live
in the city
•Rent controls and renter protection by
city laws
•Not charging renters fair market value is
“fair” aka “Social Justice”
BACK TO
Rent Control
•SF recently passed the “Relocation Assistance
Payment Ordinance”
• It requires rental property owners to pay their
tenants oppressive and unconstitutional sums of
money before the owners can regain personal
use of their property — money the tenants can
use for any private purpose they wish.
•Pacific Legal Foundation attorneys filed the
challenge to this ordinance on the basis of
Constitutional protections of property rights.
BACK TO
Rent Control
• Lawsuit is filed on behalf of homeowners
Daniel and Maria Levin, a married couple
who own a small two-unit house on
Lombard Street.
•They live in the upper unit, but are
effectively denied the right to take
occupancy of the lower unit, because of
the costly payment — $117,000, in their
case — required by the new ordinance.
•Some payments exceed $200K
BACK TO
Rent Control
• Why would anyone own or build new rental
units in SF if this ordinance stands?
• What’s the likely impact on landlords? How will
they react?
• What’s the likely impact on rental rates?
• Why would the SF City government pass such
laws?
• "In many cases rent control appears to be the
most efficient technique presently known to
destroy a city—except for bombing." - Assar
Lindbeck (Swedish economist)
BACK TO
Rent Controls
The shortage is smaller in the Short Run…
Price
(rent)
…..than in the Long Run
Short Run Supply
Long Run Supply
Market Equilibrium
Controlled
Rent
Long Run Shortage
Short Run Shortage
Qsupplied
(Long Run)
Qsupplied
(Short Run)
Demand
Qdemanded
Quantity
(rental apartments)
BACK TO
Arguments for Price Controls
So why do price controls ever get passed?
The general public may not understand the nasty
side-effects of price controls
Shortages may benefit the ruling elite…
In the former USSR, the communist party elite used Blat
to obtain goods.
Blat= having connections that can be used to get
favors.
The party elite can use their connections and power to
obtain goods for themselves or others.
Without such leverage their power dissipates.
BACK TO
Universal Price Controls
Just Another Day in a USSR Bread Line
Universal price controls caused widespread
and persistent shortages in the USSR.
Average time in line for a Soviet woman?
2 hours every day, 7 days/week.
BACK TO
SEE THE INVISIBLE HAND
Are you better or worse off when the food is included in your airfare?
Price Floors
Price floor: a minimum price allowed by
law.
not as common as price ceilings (but still
important)
Price floors have four common effects:
1. Surpluses
2. Lost gains from trade (deadweight loss)
3. Wasteful increases in quality
4. A misallocation of resources
BACK TO
Try it!
If the government of the European Union sets a price
floor for butter above the equilibrium market price,
what will be the effect?
a) Farmers will produce less butter and consumers will
purchase more, resulting in a shortage of butter.
b) The supply of butter will increase and the demand
will decrease.
c) Farmers will produce more butter and consumers
will purchase less, resulting in a surplus of butter.
d) The equilibrium price will rise to the price floor.
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Try it!
Surplus
When prices are held above the market price (price floor) quantity
supplied exceeds the quantity demanded.
Price
Supply
Controlled
Price
(Ceiling)
Surplus
Market
Price
Demand
Quantity
Qdemanded at the
Controlled Price
Qmarket Qsupplied at the
Controlled Price
BACK TO
Lost Gains from Trade
Price controls reduce the gains from trade (create deadweight
losses) Price
Deadweight Loss
= Lost Consumer Surplus
+ Lost Producer Surplus
Controlled
Price
(Floor)
Market Price
Supply
Surplus
Lost
Consumer
Surplus
Lost
Producer
Surplus
Willingness to
Sell
Demand
Qdemanded
Qmarket
Qsupplied
Quantity
BACK TO
Wasteful Increases in Quality
Price controls that create surpluses lead to wasteful increases in quality.
Supply
Price
Deadweight
Loss
Controlled
Price (Floor)
“Quality”
Waste
Market Equilibrium
Willingness
to Sell
Demand
Quantity
Qdemanded at the
Controlled Price
If they can’t lower price, sellers will find other ways to compete!
BACK TO
Wasteful Increases in Quality
Higher quality raises costs and reduces seller profit.
Buyers get higher quality, but would prefer a lower price.
Price floors encourage sellers to waste resources:
higher quality than buyers are willing to pay for
Most flyers prefer a lower price
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Misallocation of Resources
Price controls misallocate resources by:
Allowing high-cost firms to operate.
Preventing low-cost firms from entering the industry.
Regulation prevented Southwest (and 79 other firms) from
entering the national market
BACK TO
Minimum Wage
•Minimum Wage Facts
•Mandatory wage that must be paid to workers
•Workers can not negotiate for a wage lower than the
minimum wage (right of contract)
•Currently $7.25/hour as per Federal law with efforts to
raise it to $10.10/hr
•California is at $9/hr with more than half of all states
above the Federal minimum
•Less than 3% of all workers earn minimum wage (tiny)
•Largest group at minimum wage are suburban
teenagers
BACK TO
Minimum Wage
•Minimum Wage Facts
•Less than 3% of all workers earn minimum wage (tiny)
•Largest group at minimum wage are suburban
teenagers
•Historical fact: minimum wages originated as a means
to exclude women and minorities from competing
against white men
•It does not reduce poverty significantly since most
MW participants are not in “poverty” households
•Walmart is in favor of a higher minimum wage. Why?
BACK TO
How are wages determined?
•
•
•
•
Do companies pay workers on an arbitrary
basis (i.e. they pay whatever they feel like
paying)?
Economic theory applies to labor markets
Supply and demand determine price of labor
(wages)
Employers pay wages based on value of
marginal product for labor
•
i.e. employers will not pay a worker $15/hr if the
worker’s economic value (contribution) is $10/hr
BACK TO
How are wages determined?
•
Labor markets are competitive
•
•
•
Employers compete for labor, i.e. for high demand,
high-skilled workers via increased wages/benefits
Wages are based on worker productivity
(output)
Worker output is determined by skills and
capital
BACK TO
Minimum Wage
•
•
•
•
Many municipalities with much higher min wages
Seattle $15/hr phase-in for 2017
Oakland - $12.25 (March 2, 2015)
San Francisco – Passed by referendum with 77%
voter approval
• $11.05 now, rising to $12.25 in May and $15/hr in 2018
• Nevada has pending $15/hr minimum wage
legislation
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Arguments in favor of Minimum Wage
•
•
•
•
•
•
Workers need a living wage, especially those that
support a family of four
It is “fair”
Large corporations have plenty of profits to afford
this, look at WalMart’s profits
A higher minimum wage will not reduce
employment (Card-Kruger study)
Labor “deserves” higher share of profits in
capitalist-type economies
Higher minimum wage will stimulate economic
spending, hence “pay” for the MW increase
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Arguments in favor of Minimum Wage
• Raising the minimum wage will reduce spending
by government, i.e. less welfare & food stamps
• Higher wages will increase worker productivity
i.e. workers will “earn” the increase
• Employers are engaged in monopsonistic
behavior against low-skilled workers
• Minimum wage increases are always followed by
a surge in economic growth (2007 increase?)
• Seven Nobel Prize winners in economics are in
favor of a higher minimum wage, asserting that
the loss of employment is a negligible effect
BACK TO
Arguments Against Minimum Wage
• Employers will hire less workers
• Prevents lowest-skilled workers from being hired
• Workers with the lowest skills will be the first to be
laid off or not hired as a result
• Substitution of capital for labor (robots,
automation)
• Where does the money for increased labor costs
come from?
•
•
Less profits?
Higher prices? – Studies show higher prices
disproportionately affect lower income workers
BACK TO
Arguments Against Minimum Wage
• Minimum wage is a training wage, allows
acquisition of skills, higher productivity
• Provides incentives to workers to acquire more
skills
• Working for a living breaks the culture of
dependency and increased taxes on others
• If $9.00/hr min wage is good, isn’t a $20/hr min
wage better? How to draw the line?
•
•
When min wage goes to $15/hr, a large percentage of
the labor market gets an increase (20% ?)
Have we discovered the secret of higher standards of
living? Or the “something for nothing” principle?
BACK TO
Arguments Against Minimum Wage
• Who else benefits from a higher minimum wage?
•
•
Low-skill, low pay workers are substitutes for higherskilled, higher pay workers
Labor unions are labor monopolies supported by US
laws such as the Wagner Act (Great Depression)
• Where did all of the elevator operators,
gas station attendants, and movie theatre
ushers go?
• Whatever happened to “equal pay for
equal work?”
BACK TO
Impacts of Minimum Wage Increases
• All labor markets have downward sloping
demand curves
• Raising wages results in less labor hired by employers
• Employers will cut non-wage worker benefits to
compensate for higher costs
• Workers may be pressured to work harder or face
termination
• Higher earnings may result in workers asking for
fewer hours due to loss of government benefits
• ACA has amplified these problems
• Casey Mulligan, University of Chicago labor economist
BACK TO
Evidence
• CBO Study 2014
• Increase from $7.25 to $10.10/hour will result in the
loss of 500,000 jobs
• Newmark Minimum Wage Study results
• Teenage unemployment rates much higher than
overall U3 unemployment rate
• European min wages are much higher than US
and teenage unemployment rates in EU are much
higher than US
• Announcements in SF and Seattle of small business
closings in response to $15/hr wage laws
BACK TO
Evidence
• Special case: American Samoa
• Tuna processing plants exempted from US min wage
laws
• Why?
• Great Depression – minimum wage began at
$.25/hour
• Applied to Puerto Rico and cause massive layoffs
BACK TO
BACK TO
Minimum Wage – Economic Ignorance
•
From 7/12/14 internet advertisement:
BACK TO
Minimum Wage – Economic Ignorance
• What’s wrong with this?
• Higher wages lead to more hiring?
• Wage increases for just 3% of the labor market stimulates
the economy sufficiently to produce significant job
growth overall?
• No other economic factors affect the job market?
• What would have happened to job growth if the
minimum wage increase had not been passed in these
states?
• Time frame: minimum wages raises occurred in early
2014 and yet by July 2014 the claimed impact had
already occurred?
• This is an example of “lying with statistics” - it preys upon
the ignorant and harms society
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Minimum Wage - Summary
• The minimum wage argument is and will always
be about politics and vote buying:
• Pro-min wage increase is the “compassionate caring”
position
• People against the min wage increase are uncaring,
haters
• Many pro-minimum wage arguments rely on the
ignorance of the (voting) public
• Confusion between money and real output
• Much of this goes back to bad economic theory,
i.e. Marx’s Labor Theory of Value
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Minimum Wage - Summary
• The REAL problem with the minimum wage:
• Government interference in the economy
• Good intentions do not guarantee good outcomes
• Minimum wage policy is part of the continual
propaganda that the government “runs” the
economy and knows best how to control and
adjust (i.e. “creating jobs” or “Thank God for
government spending”
• Hayek called this – “The pretense of knowledge”
• The belief that the government can improve overall
economic outcomes with price controls
• The collectivist belief in the “free lunch” and free
riders
BACK TO
Minimum Wage - Summary
• “Government is the great fiction,
through which everybody endeavors
to live at the expense of everybody
else.”
• – Frederic Bastiat
BACK TO
SEE THE INVISIBLE HAND
President Jimmy Carter deregulated the
price floors in much of the trucking industry.
Trucks carry almost all of the consumer
goods that you purchase, so almost every
time you purchase something, you're paying
money to a trucking company. What do you
think happened in the trucking industry after
deregulation?
a) The price of trucking services fell.
b) Truckers earned less money.
c) Consumers saved a lot of money.
d) All of the above are correct.
Try it!
If the U.S. government sets a price floor on milk,
it will not always lead to a surplus. Why not?
a)
b)
c)
d)
The price floor would be rarely enforced.
Because price floors most commonly lead
to shortages, not surpluses.
The market price of milk will sometimes rise
above the price floor, rendering the price
floor irrelevant.
Price floors cause supply and demand to
change, which leads to changes in
To next
Try it!
equilibrium price.
Try it!
During research for a class you find out that
in the year 301, the Roman Emperor
Diocletian issued an “Edict on Prices” for
shoes and you want to find out if it was a
price ceiling or a price floor. Further
research tells you that the number of shoes
sold dropped dramatically and that both
sellers and buyers were very upset. Was it a:
a) Price ceiling
b) Price floor
c) Not enough information
BACK TO