PRICE CEILINGS AND PRICE FLOORS
ECO 2023
Principles of Microeconomics
Dr. McCaleb
Price Ceilings and Price Floors
1
TOPIC OUTLINE
I.
Price Ceilings
II. Price Floors
Price Ceilings and Price Floors
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Price Ceilings
Price Ceilings and Price Floors
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PRICE CEILINGS
 Price Ceiling
Definition
A maximum legal price for a good, service, or activity.
A price ceiling that is set below the equilibrium price is a source of
inefficiency in the market, resulting in a deadweight loss from
underproduction.
A price ceiling set above the equilibrium has no effect on the market.
Except for temporary aberrations, the market price would not rise
above the equilibrium even without the price ceiling.
Price Ceilings and Price Floors
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PRICE CEILINGS
 Example: Rent Controls
Rent controls are a form of price ceiling
Rent controls are government regulations that make it illegal to charge
more than a specified rent for housing.
All price ceilings have similar effects, but because there is a long
history of rent control in New York City and also a shorter history in
some other localities, especially in California, we have lots of
experience with rent control. That makes rent control particularly
useful for illustrating the effects of price ceilings.
Price Ceilings and Price Floors
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PRICE CEILINGS
Efficiency in the Rental
Housing Market
In a free market, the demand for
and supply of housing determine the
equilibrium rent of $550 a month
and the equilibrium quantity of
4,000 units of rental housing.
Price Ceilings and Price Floors
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PRICE CEILINGS
Efficiency in the Rental
Housing Market
In a free market with no rent
controls, the equilibrium quantity of
rental housing is efficient.
The marginal benefit of rental
housing at the equilibrium quantity
equals its marginal cost.
The sum of consumer and producer
surplus is maximized.
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PRICE CEILINGS
Rent Controls Create a
Rental Housing Shortage
Suppose a rent ceiling of $400 a
month is imposed. At the rent
ceiling . . .
• the quantity of rental housing
supplied is 3,000 units.
• the quantity of rental housing
demanded is 6,000 units.
•
there is a shortage of 3,000
rental housing units.
Price Ceilings and Price Floors
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PRICE CEILINGS
Inefficiency of Rent
Controls
A rent ceiling limits the quantity
supplied below the efficient
quantity. There is underproduction
of rental housing.
Marginal benefit at the rentcontrolled quantity exceeds
marginal cost.
Consumer surplus (green area) and
producer surplus (blue area) are
both smaller than in the free market
equilibrium.
Price Ceilings and Price Floors
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PRICE CEILINGS
Inefficiency of Rent
Controls
The reduction in consumer and
producer surplus is a deadweight
loss.
What happens to the surplus below
the marginal benefit at the rentcontrolled quantity and the rentcontrolled price?
You might think it is a gain to
consumers. But in fact it may
simply be wasted in excess search
costs.
Price Ceilings and Price Floors
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PRICE CEILINGS
Inefficiency of Rent
Controls
Because of the shortage of rental
housing, consumers may use up any
gains in
• wasteful search activity
• bribes, side payments, and
other legal or illegal payments
to secure housing
• evasion of the law.
Even though the price is lower, the
opportunity cost of housing may
actually be higher than in a free
market without rent controls.
Price Ceilings and Price Floors
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Use statements I and II to answer the question. I. Rent
controls result in underproduction of rental housing. II. With
rent controls, the sum of consumer and producer surplus is
less than at the free market equilibrium.
1.
Both I and II are true.
2.
Both I and II are false.
3.
I is true; II is false.
4.
I is false; II is true.
Price Ceilings and Price Floors
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Use statements I and II to answer the question. I. Rent
controls result in a shortage of rental housing and wasteful
search activity to find and obtain rental housing. II. The true
opportunity cost of rental housing may be higher with rent
controls than in an uncontrolled free market even though the
price is lower.
1.
Both I and II are true.
2.
Both I and II are false.
3.
I is true; II is false.
4.
I is false; II is true.
Price Ceilings and Price Floors
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PRICE CEILINGS
 Example: Rent Controls
Effects of rent controls on rental housing markets
In addition to increasing the costs to consumers of finding rental
housing, rent controls have three other major effects on the rental
housing market.
• Decline in the quality of rental housing
• Decrease in the quantity of rental housing
• Inefficient use of rental housing space
Price Ceilings and Price Floors
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PRICE CEILINGS
 Example: Rent Controls
Decline in quality of rental housing
The rent ceiling prevents rents from increasing to cover cost
increases. Therefore, landlords have an incentive to limit cost
increases by reducing maintenance and renovation expenses.
Because of the rent ceiling, landlords who invest in maintenance and
renovation are often unable to obtain a reasonable return on their
investment.
The result is a deterioration of rental housing, often ultimately
leading to abandonment.
Price Ceilings and Price Floors
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PRICE CEILINGS
 Example: Rent Controls
Decrease in the quantity of rental housing
Over time, the quantity of rental housing decreases because of
• conversion of existing rental housing to other uses—for
example, commercial rental property, condominiums, and
cooperatives.
• withdrawal of rental housing units from the market
• absence of new construction to replace existing rental housing
as it wears out or to increase the rental housing stock to keep
pace with increases in demand.
Price Ceilings and Price Floors
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PRICE CEILINGS
 Example: Rent Controls
Inefficient use of housing space
Landlords are often permitted to raise rents when a housing unit is
vacated and re-rented. Therefore, tenants have incentives not to
move.
Turnover of rental housing is low even when it would be efficient for
tenants to move to larger or smaller units. This results in inefficient
use of rental housing space, called housing gridlock.
Rental housing is not occupied by people who value it the most.
Older singles and childless couples continue to occupy large housing
units. Younger families with children are relegated to smaller housing
units.
Price Ceilings and Price Floors
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PRICE CEILINGS
 Example: Rent Controls
Who gains from rent controls?
Consumers who obtain rent-controlled housing units and who don’t
move gain (provided they don’t exhaust the additional consumer
surplus in search costs or side payments).
These are most likely to be people who
•
•
•
•
are older, more established, longer-term, less transient
are middle and upper income with good credit
are better connected with better access to market information
possess skills valued by landlords
Price Ceilings and Price Floors
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PRICE CEILINGS
 Example: Rent Controls
Who loses from rent controls?
Landlords, of course, but also consumers who are unable to find the
quality and quantity of rental housing they desire and for which they
are willing to pay.
These are most likely to be people who
• are younger, newer to the community, more transient
• have lower incomes with no or poor credit
• lack connections and do not have access to good market
information
• have families, especially larger families.
Price Ceilings and Price Floors
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PRICE CEILINGS
 Example: Rent Controls
Other losers from rent controls
Individuals who choose not to live in the community because of the
shortage of rental housing, the high search costs, and the inferior
quality of rental housing.
Taxpayers, who bear the cost of enforcing rental housing ordinances.
In the long run, even people in rent-controlled apartments may lose if
they pay a lower price for housing of inferior quality that is either
larger or smaller than they really desire.
Price Ceilings and Price Floors
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Which of the following is NOT a likely effect of rent controls ?
1. The quality of rental housing deteriorates
2. The quantity of rental housing declines.
3. Rental housing space is used inefficiently.
4. Rental housing is more available and affordable for low
income people.
Price Ceilings and Price Floors
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Which of the following is most likely to be better off with rent
controls than in an unregulated free market?
1. A young, middle income couple with 3 children who
recently moved to New York City.
2. A single professional person working in New York who
wanted to live near work but settled for living in (egad!)
New Jersey.
3. A poor single mother who often has to move because of
poor credit and inability to pay rent on time.
4. An older, upper income couple living in the same rentcontrolled apartment for the last 25 years.
Price Ceilings and Price Floors
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Price Floors
Price Ceilings and Price Floors
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Is This an Effective Anti-Poverty Program?
25%-50% of the people targeted by the program do not live in
poor households.
More than half the people who do live in poor households do
not benefit from the program.
Even among people in poor households who benefit from the
program, the benefits are insufficient to lift them out of
poverty.
The program pushes some poor people further into poverty.
Price Ceilings and Price Floors
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PRICE FLOORS
 Price Floor
Definition
A minimum legal price for a good, service, or activity.
A price floor that is set above the equilibrium price is a source of
inefficiency in the market, resulting in a deadweight loss.
A price floor set below the equilibrium has no effect on the market.
Except for temporary aberrations, the market price would not fall
below the equilibrium even without the price floor.
Price Ceilings and Price Floors
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PRICE FLOORS
 Example 1: Minimum Wage
A minimum wage is a price floor
A minimum wage (also referred to now as a “living wage”) establishes
a minimum legal price that employers must be to hire labor.
Minimum wages are the best-known and perhaps most common
examples of price floors.
Price Ceilings and Price Floors
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PRICE FLOORS
Efficiency in the Labor
Market
In a free market, the demand for
and supply of fast-food servers
determine the equilibrium wage of
$5.00 an hour and the equilibrium
quantity of 5,000 servers.
Price Ceilings and Price Floors
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PRICE FLOORS
Efficiency in the Labor
Market
In a free market, the equilibrium
quantity of employment is efficient.
The marginal benefit of labor to
employers equals the workers’
marginal cost to work.
The sum of employers’ (consumer)
surplus and workers’ (producer)
surplus is maximized.
Price Ceilings and Price Floors
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PRICE FLOORS
A Minimum Wage Creates
Unemployment
Suppose a minimum wage of $7 an
hour is imposed. At the minimum
wage . . .
• the quantity of labor demanded is
3,000 workers.
• the quantity of labor supplied is
7,000.
• there is an excess supply of
labor, or unemployment, of
4,000.
Price Ceilings and Price Floors
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PRICE FLOORS
A Minimum Wage Is
Inefficient
A minimum wage limits the
quantity demanded below the
efficient quantity.
Employers’ marginal benefit of
labor exceeds workers’ marginal
cost.
Employers’ surplus (green area) and
workers’ surplus (blue area) are
both smaller than in the free market.
Price Ceilings and Price Floors
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PRICE FLOORS
A Minimum Wage Is
Inefficient
The minimum wage gives rise to a
deadweight loss in the labor market.
Because of unemployment and the
shortage of jobs, it is difficult for
minimum-wage workers to find
jobs and they waste resources in
unproductive search activity.
Price Ceilings and Price Floors
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PRICE FLOORS
 Example 1: Minimum Wage
Who gains from a minimum wage?
Workers who succeed in obtaining as many hours of employment as
they want to work at the higher minimum wage. They earn more than
without the minimum wage.
Higher wage workers, often unionized, for whom low-wage,
unskilled workers are substitutes. By raising the wage that employers
must pay for the lower-wage, unskilled workers, the minimum wage
makes those workers less competitive with the higher wage workers.
Price Ceilings and Price Floors
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PRICE FLOORS
 Example 1: Minimum Wage
Who loses from the minimum wage?
Employers, of course.
Low-wage, unskilled workers who are unable to find work or whose
whose hours of work are limited because of the minimum wage.
Even workers who initially find jobs at the minimum wage may lose
if they use up all of their wage gains searching for a job.
All low-wage, unskilled workers may lose in the long run if
employers substitute capital for labor because of the higher minimum
wage.
Price Ceilings and Price Floors
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A minimum wage _____ the quantity demanded of labor by
employers and ___ the quantity supplied of labor by workers.
1.
Increases; increases
2.
Increases; decreases
3.
Decreases; increases
4.
Decreases; decreases
Price Ceilings and Price Floors
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True (T) or false (F): A minimum wage benefits all low-wage
workers by raising their incomes.
Price Ceilings and Price Floors
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PRICE FLOORS
 Example 2: Agricultural Price Supports
Agricultural price supports are an example of a price
floor
Government establishes minimum prices or price floors for many
agricultural products.
Unlike the minimum wage, government does not make it illegal to
buy or sell below the price floor. Instead, government provides an
incentive to farmers not to sell below the price floor.
Government does this by agreeing to buy any amount that farmers
want to sell at the price floor. In other words, government “supports”
the price floor by being a buyer of last resort.
Price Ceilings and Price Floors
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PRICE FLOORS
How a Price Support Works
With no price support, the
equilibrium price is $25 and the
equilibrium quantity is 25 million
tons.
At a support price of $35, QD is 20
million tons and QS is 30 million
tons. There is a surplus of 10
million tons.
To prevent the price from falling
below $35, government buys up the
surplus. The amount of the resulting
subsidy to farmers is shown by the
pink rectangle.
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PRICE FLOORS
Inefficiency of Price
Supports
The competitive market equilibrium
quantity, 25 million tons, is
efficient. But with the price support,
QS=30 million tons.
The market with a price support is
inefficient because of
overproduction, which results in a
deadweight loss shown by the gray
triangle.
Price Ceilings and Price Floors
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Use statements I and II to answer this question. (I).
Agricultural price supports result in surpluses which must be
purchased by the government. (II). Agricultural price supports
increase economic efficiency by guaranteeing farmers a
market for their products.
1. Both I and II are true.
2.
Both I and II are false.
3.
I is true; II is false.
4.
I is false: II is true.
Price Ceilings and Price Floors
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PRICE FLOORS
 Minimum Wage
Disemployment effect and earnings effect
Disemployment effect
The loss in total earnings due to the reduction in employment caused
by the higher minimum wage.
Earnings effect
The gain in total earnings due to the increased wage paid to workers
who are employed at the higher minimum wage.
Price Ceilings and Price Floors
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APPLICATIONS: PRICE FLOORS
Disemployment Effect
With a minimum wage of $7.00 an
hour, employment falls to 3,000
workers.
The disemployment effect (the
green area) is the loss in earnings
from the reduction in employment.
Wage rate (dollars per hour)
The equilibrium wage rate is $5.00
an hour and the equilibrium level of
employment is 5,000 workers.
12
10
S
8
Minimum
wage
6
4
2
0
0 1 2 3 4
It is equal to the decrease in
employment times the equilibrium
wage.
D
Disemployment effect
5
6
7
8
9 10
Quantity (thousands
(thousands of
of workers)
workers)
Price Ceilings and Price Floors
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APPLICATIONS: PRICE FLOORS
Earnings Effect
With a minimum wage of $7.00 an
hour, the 3,000 workers who are
employed earn $7.00 an hour
instead of $5.00 an hour.
The earnings effect (the blue area)
is the increase in earnings from the
higher wage.
It is equal to the increase in the
wage times the number of hours
employed at the higher minimum
wage.
Wage rate (dollars per hour)
12
10
S
8
Minimum
wage
6
4
Earnings
effect
2
D
0
0 1 2 3 4
5
6
7
8
9 10
Quantity (thousands
(thousands of
of workers)
workers)
Price Ceilings and Price Floors
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APPLICATIONS: PRICE FLOORS
 Minimum Wage
Does a minimum wage raise or lower the earnings of
low wage workers?
If the disemployment effect is larger than the earnings effect, the
minimum wage has a negative net effect on total earnings of low
wage workers.
If the disemployment effect is smaller than the earnings effect, the
minimum wage has a positive net effect on total earnings of low
wage workers.
Price Ceilings and Price Floors
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