Price and quantity controls

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Lesson Overview
Chapter 5 Price and Quantity Controls
Why Governments Control Prices
Price Ceilings
How Price Ceilings Cause Inefficiency
So Why are there Price Ceilings?
Price Floors
How Price Floors Cause Inefficiency
Quantity Controls
Controversy: Minimum Wages
Summary
Review Questions
BA 210 Lesson I.6 Price and Quantity Controls
1
Why Governments Control Prices
Why Governments Control Prices
• The market price moves to the level at which the quantity
supplied equals the quantity demanded. But this equilibrium
price does not necessarily please all buyers or all sellers.
• Therefore, the government intervenes to regulate prices by
imposing price controls, which are legal restrictions on how
high or low a market price may go.
• Price ceiling 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.
BA 210 Lesson I.6 Price and Quantity Controls
2
Price Ceilings
• Price ceilings are typically imposed during crises because these
events often lead to sudden price increases that hurt many
people but produce big gains for a lucky few.
BA 210 Lesson I.6 Price and Quantity Controls
3
Price Ceilings
The Market for Apartments in the Absence of Government
Controls
Monthly rent (per apartment)
S
$1,400
Monthly rent
(per apartment)
1,300
1,200
1,100
E
1,000
900
800
700
600
0
D
1.6
1.7
1.8
1.9
2.0
2.1
2.2
2.3
$1,400
1,300
1,200
1,100
1,000
900
800
700
600
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
2.4
Quantity of apartments (millions)
BA 210 Lesson I.6 Price and Quantity Controls
4
Price Ceilings
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)
BA 210 Lesson I.6 Price and Quantity Controls
5
Price Ceilings
How Price Ceilings Cause Inefficiency
• Inefficiently Low Quantity
 Deadweight loss is the loss in total surplus that occurs
whenever an action or a policy reduces the quantity
transacted below the efficient market equilibrium quantity
 It is the guaranteed minimum loss from a price ceiling.
 Three other types of loss are likely.
• Inefficient Allocation to Customers
• Wasted Resources
• Inefficiently Low Quality
BA 210 Lesson I.6 Price and Quantity Controls
6
Price Ceilings
A Price Ceiling Causes Inefficiently Low Quantity
First, assume only consumers with most value get the good.
Monthly
rent (per
apartment)
Deadweight loss
from fall in number
of apartments
rented
$1,400
S
1,200
E
1,000
Price
ceiling
800
600
0
D
1.6
1.8
Quantity supplied
with rent control
2.0
2.2
2.4
Quantity of apartments (millions)
Quantity supplied without
rent control
BA 210 Lesson I.6 Price and Quantity Controls
7
Price Ceilings
Winners and Losers from Rent Control
(a) Before Rent Control
Monthly
rent
(per
apartment)
Consumer
surplus
S
(b) After Rent Control
Monthly
rent
(per
apartment)
$1,400
$1,400
1,200
1,200
E
1,000
S
transferred from
producers
Price
ceiling
E
1,000
800
800
600
0
Consumer
surplus Consumer surplus
600
Producer
surplus
1.6
1.8
Producer
surplus
D
2.0
2.2
2.4
Quantity of apartments (millions)
0
1.6
1.8
Deadweight
loss
2.0
2.2
D
2.4
Quantity of apartments (millions)
BA 210 Lesson I.6 Price and Quantity Controls
8
How Price Ceilings Cause Inefficiency
• Price ceilings often lead to inefficiency in the form of
inefficient allocation to consumers: some people who are
willing to pay the highest prices don’t get it, and those only
willing to pay less do get it.
 If Abe is willing to pay $1,300 for an apartment but does not
get it, and Burt is willing to pay only $1,100 and does get it,
there is $200 lost surplus, in addition to deadweight loss.
• Price ceilings typically lead to inefficiency in the form of
wasted resources: potential expend money, effort and time to be
able to buy at the low ceiling prices.
• If Abe is willing to pay $1,300 for an apartment and Burt is
willing to pay only $1,100 and does get it, then Abe is
willing to pay up to $200 more than Burt in money, effort
and time to be able to buy at the low ceiling prices.
BA 210 Lesson I.6 Price and Quantity Controls
9
How Price Ceilings Cause Inefficiency
• Price ceilings often lead to inefficiency in that the goods being
offered are of inefficiently low quality: sellers offer low-quality
goods at a low price even though buyers would prefer a higher
quality at a higher price.
 Because there is a surplus of renters under rent control, if
renters valued a renovation at $100 each, and the owner
could provide the renovation for $40 each, that renovation
will not be done because the owner cannot recoup any of the
cost, even though the renovation would increase surplus by
$60 for each renter.
BA 210 Lesson I.6 Price and Quantity Controls
10
How Price Ceilings Cause Inefficiency
• A black market is a market in which goods or services are
bought and sold illegally—either because it is illegal to sell
them at all or because the prices charged are legally prohibited
by a price ceiling.
BA 210 Lesson I.6 Price and Quantity Controls
11
So Why are there Price Ceilings?
Case: Rent Control in New York
• Price ceilings hurt most residents but give a small minority of
renters much cheaper housing than they would get in an unregulated
market (those who benefit from the controls are typically better
organized and more influential than those who are harmed by them).
• When price ceilings have been in effect for a long time, buyers may
not have a realistic idea of what would happen without them.
• Government officials often do not understand supply and demand
analysis!
BA 210 Lesson I.6 Price and Quantity Controls
12
Price Floors
• Sometimes governments intervene to push market prices up
instead of down.
• The minimum wage is a legal floor on the wage rate, which is
the market price of labor.
• Just like price ceilings, price floors are intended to help some
people but generate predictable and undesirable side effects.
BA 210 Lesson I.6 Price and Quantity Controls
13
Price Floors
The Market for Butter in the Absence of Government Controls
Price of
butter
(per
pound)
$1.40
S
Quantity of butter
(millions of pounds)
1.30
1.20
1.10
E
1.00
0.90
0.80
0.70
0.60
D
0
6
7
8
9
10
11
12
13
Price of butter
(per pound)
Quantity
demanded
Quantity
supplied
$1.40
$1.30
$1.20
$1.10
$1.00
$0.90
$0.80
$0.70
$0.60
8.0
8.5
9.0
9.5
10.0
10.5
11.0
11.5
12.0
14.0
13.0
12.0
11.0
10.0
9.0
8.0
7.0
6.0
14
Quantity of butter (millions of pounds)
BA 210 Lesson I.6 Price and Quantity Controls
14
Price Floors
The Effects of a Price Floor
Price of
butter
(per pound)
Butter surplus of 3
million pounds caused by
price floor
$1.40
S
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)
BA 210 Lesson I.6 Price and Quantity Controls
15
How Price Floors Cause Inefficiency
• The persistent surplus that results from a price floor creates
missed opportunities—inefficiencies—that resemble those
created by the shortage that results from a price ceiling. These
include:
 Deadweight loss from inefficiently low quantity
 Inefficient allocation of sales among sellers
 Wasted resources
 Inefficiently high quality
BA 210 Lesson I.6 Price and Quantity Controls
16
How Price Floors Cause Inefficiency
A Price Floor Causes Inefficiently Low Quantity
First, assume only suppliers with lowest cost supply the good.
S
Price of $1.40
butter
(per pound)
1.20
Deadweight
loss
Price
floor
E
1.00
0.80
0.60
0
D
6
8
Quantity
demanded with
price floor
9
10
12
14
Quantity demanded
without price floor
BA 210 Lesson I.6 Price and Quantity Controls
Quantity of butter
(millions of pounds)
17
How Price Floors Cause Inefficiency
• Price floors lead to 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.
• If Abe’s cost to sell butter is $0.60 but does not get to sell,
and Burt’s cost to sell butter is $0.80 and does get to sell,
there is $0.20 lost surplus, in addition to deadweight loss.
• Price floors often lead to inefficiency in that goods of
inefficiently high quality are offered: sellers offer high-quality
goods at a high price, even though buyers would prefer a lower
quality at a lower price.
• Likewise, to complete for buyers, Abe may advertise his
butter at a significant cost, which is lost surplus in addition
to deadweight loss.
BA 210 Lesson I.6 Price and Quantity Controls
18
Quantity Controls
• A quantity control, or quota, is an upper limit on the quantity
of some good that can be bought or sold. The total amount of
the good that can be legally transacted is the quota limit. An
example is the taxi medallion system in New York.
• A license gives its owner the right to supply a good.
• 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.
BA 210 Lesson I.6 Price and Quantity Controls
19
Quantity Controls
The Market for Taxi Rides in the Absence of Government
Controls
S
$7.00
Fare
6.50
(per
ride) 6.00
5.50
Fare
(per ride)
Quantity
demanded
6
Quantity
supplied
14
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
E
$7.00
$6.50
5.00
4.50
4.00
3.50
3.00
0
Quantity of rides
(millions per year)
D
6
7
8
9
10
11
12
13
14
Quantity of rides (millions per year)
BA 210 Lesson I.6 Price and Quantity Controls
20
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)
BA 210 Lesson I.6 Price and Quantity Controls
21
Quantity Controls
How Quantity Controls Work
• A quantity control, or quota, drives a wedge between the
demand price and the supply price of a good; that is, the price
paid by buyers ends up being higher than that received by
sellers.
• The difference between the demand and supply price at the
quota limit is the quota rent, 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 licenses are
traded.
BA 210 Lesson I.6 Price and Quantity Controls
22
Quantity Controls
The Costs of Quantity Controls
• Deadweight loss because some mutually beneficial transactions
don’t occur.
• Incentives for illegal activities.
BA 210 Lesson I.6 Price and Quantity Controls
23
Controversy: Minimum Wages
Controversy: Minimum Wages
BA 210 Lesson I.6 Price and Quantity Controls
24
Controversy: Minimum Wages
A minimum wage is the lowest hourly, daily or monthly wage
that employers may legally pay to employees or workers.
Equivalently, it is the lowest wage at which workers may sell
their labor. Although minimum wage laws are in effect in a great
many jurisdictions, there are differences of opinion about the
benefits and drawbacks of a minimum wage. Supporters of the
minimum wage say that it increases the standard of living of
workers and reduces poverty. Opponents say that if it is high
enough to be effective, it increases unemployment, particularly
among workers with very low productivity due to inexperience or
handicap, thereby harming lesser skilled workers to the benefit of
better skilled workers.
BA 210 Lesson I.6 Price and Quantity Controls
25
Controversy: Minimum Wages
Question: Use demand and supply curves to show the following
surplus looses from minimum wages designed to help
unproductive workers:
 the lost producer surplus from the inefficient allocation of
employment (some with higher opportunity costs are employed
while other potential workers with lower costs are not
employed)
 the lost total surplus as minimum wages reduce employment.
 the wasted resources from potential workers competing for
employment.
BA 210 Lesson I.6 Price and Quantity Controls
26
Controversy: Minimum Wages
Answer: The lost producer surplus if some with higher costs
supply labor while others with lower costs do not sell labor.
S
Minimum
wage
Y
$7
E
$6
X
Loss in producer surplus
if Yvonne successfully
competes to sell labor
instead of Xavier
$5
D
0
1,000
Quantity of labor
BA 210 Lesson I.6 Price and Quantity Controls
27
Controversy: Minimum Wages
The lost total surplus from reduced employment.
S
Wage rate $1.40
(per hour)
1.20
Deadweight
loss
Minimum
wage
E
1.00
0.80
0.60
0
D
6
8
9
Labor demanded
with minimum
wage
10
12
14
Labor demanded
without minimum
wage
BA 210 Lesson I.6 Price and Quantity Controls
Employment of labor
(millions of hours)
28
Controversy: Minimum Wages
The wasted resources of each unit of labor if they compete for
jobs by waiting in line for each unit of employment. Only the
first 800 units are employed, and they each pay $20 to compete
for employment.
S
Minimum
wage
$70
E
$60
$50
D
0
800
1,000
Quantity of labor (days)
BA 210 Lesson I.6 Price and Quantity Controls
29
Controversy: Minimum Wages
Comment: If each unit of labor competes by waiting in line for
each unit of employment, each pays $20 to compete and so is
paid the minimum $70 but nets only $50, which is less than if
there were no minimum wage.
S
Minimum
wage
$70
E
$60
$50
D
0
800
1,000
Quantity of labor (days)
BA 210 Lesson I.6 Price and Quantity Controls
30
Summary
Summary
1. Even when a market is efficient, governments often intervene
to pursue greater fairness (although putting needy people on
welfare would be more effective) or to please a powerful
interest group. Interventions can take the form of price
controls or quantity controls, both of which generate
predictable and undesirable side effects.
BA 210 Lesson I.6 Price and Quantity Controls
31
Summary
Summary
2. A price ceiling, a maximum market price below the
equilibrium price, benefits successful buyers but creates
persistent shortages. Price ceilings lead to inefficiencies in
the form of deadweight loss from inefficiently low quantity,
inefficient allocation to consumers, wasted resources, and
inefficiently low quality. It also encourages illegal activity
(tempting citizens to break the law) as people turn to black
markets to get the good.
BA 210 Lesson I.6 Price and Quantity Controls
32
Summary
Summary
3. A price floor, a minimum market price above the equilibrium
price, benefits successful sellers but creates persistent
surplus. Price floors lead to inefficiencies in the form of
deadweight loss from inefficiently low quantity, inefficient
allocation of sales among sellers, wasted resources, and
inefficiently high quality. It also encourages illegal activity
and black markets. The most well-known kind of price floor
is the minimum wage, but price floors are also commonly
applied to agricultural products.
BA 210 Lesson I.6 Price and Quantity Controls
33
Summary
Summary
4. Quantity controls, or quotas, limit the quantity of a good that
can be bought or sold. The quantity allowed for sale is the
quota limit. The government issues licenses to individuals,
the right to sell a given quantity of the good. Economists say
that a quota drives a wedge between the demand price and
the supply price; this wedge is equal to the quota rent.
Quantity controls lead to deadweight loss in addition to
encouraging illegal activity.
BA 210 Lesson I.6 Price and Quantity Controls
34
Review Questions
Review Questions
 You should try to answer some of the following questions
before the next class.
 You will not turn in your answers, but students may request
to discuss their answers to begin the next class.
 Your upcoming Exam 1 and cumulative Final Exam will
contain some similar questions, so you should eventually
consider every review question before taking your exams.
BA 210 Lesson I.6 Price and Quantity Controls
35
Review Questions
Follow the link
http://faculty.pepperdine.edu/jburke2/ba210/PowerP1/Set5Answers.pdf
for review questions for Lesson I.6 that practices these skills:
 Identify the effective and ineffective price ceilings and floors.
 Compute the shortage and reduced supply from a price ceiling.
 Identify the inefficiencies from a price ceiling:
 loss from lowered quantity as some previous consumers no longer consume and some
previous sellers no longer sell,
 an inefficient allocation to consumers (some with higher willingness to pay do not
consume while others with lower willingness to pay consume),
 wasted resources from consumers competing to buy,
 inefficiently low quality.
 Compute the surplus and reduced demand from a price floor.
 Identify the inefficiencies from a price floor:
 loss from lowered quantity as some previous consumers no longer consume and some
previous sellers no longer sell,
 an inefficient allocation to producers (some with higher costs produce while others with
lower costs do not produce),
 wasted resources from producers competing to sell,
 inefficiently high quality.
 Compute the deadweight loss of a quota.
 Compute the quota rent, as the value of the right to sell under the quota.
BA 210 Lesson I.6 Price and Quantity Controls
36
BA 210
Introduction to Microeconomics
End of Lesson I.6
BA 210 Lesson I.6 Price and Quantity Controls
37
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