Supply/Demand Review Video:
http://www.youtube.com/watch?v=RP0j3Lnlazs
Price Floor/Ceiling Review Video:
http://www.youtube.com/watch?v=Ffcd6Wdkn5w
© 2007 Thomson South-Western
CONTROLS ON PRICES
• Are usually enacted when policymakers
believe the market price is unfair to buyers or
sellers.
• Result in government-created price ceilings
and floors.
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CONTROLS ON PRICES
• Price Ceiling
– A legal maximum on the price at which a good can
be sold.
• Price Floor
– A legal minimum on the price at which a good can
be sold.
© 2007 Thomson South-Western
How Price Ceilings Affect Market
Outcomes
• Two outcomes are possible when the
government imposes a price ceiling:
• The price ceiling is not binding if set above the
equilibrium price.
• The price ceiling is binding if set below the
equilibrium price, leading to a shortage.
© 2007 Thomson South-Western
Figure 1 A Market with a Price Ceiling
(a) A Price Ceiling That Is Not Binding
Price of
Ice-Cream
Cone
Supply
$4
Price
ceiling
3
The market clears at
$3 and the price
ceiling is ineffective.
Equilibrium
price
Demand
0
100
Equilibrium
quantity
Quantity of
Ice-Cream
Cones
© 2007 Thomson South-Western
Figure 1 A Market with a Price Ceiling
(b) A Price Ceiling That Is Binding
Price of
Ice-Cream
Cone
Supply
Equilibrium
price
$3
2
Price
ceiling
Shortage
Demand
0
75
125
Quantity
supplied
Quantity
demanded
Quantity of
Ice-Cream
Cones
© 2007 Thomson South-Western
How Price Ceilings Affect Market
Outcomes
• Effects of Price Ceilings
• A binding price ceiling creates
• Shortages because QD > QS.
• Example: Gasoline shortage of the 1970s
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CASE STUDY: Lines at the Gas Pump
• In 1973, OPEC raised the price of crude oil
in world markets. Crude oil is the major
input in gasoline, so the higher oil prices
reduced the supply of gasoline.
• $0.38 to $0.84
• What was responsible for the long gas lines?
• Economists blame government
regulations that limited the price oil
companies could charge for gasoline.
© 2007 Thomson South-Western
Figure 2 The Market for Gasoline with a Price Ceiling
(a) The Price Ceiling on Gasoline Is Not Binding
Price of
Gasoline
Supply, S1
1. Initially,
the price
ceiling
is not
binding . . .
Price ceiling
P1
Demand
0
Q1
Quantity of
Gasoline© 2007 Thomson South-Western
Figure 2 The Market for Gasoline with a Price Ceiling
(b) The Price Ceiling on Gasoline Is Binding
Price of
Gasoline
S2
2. . . . but when
supply falls . . .
S1
P2
Price ceiling
3. . . . the price
ceiling becomes
binding . . .
P1
4. . . .
resulting
in a
shortage.
Demand
0
QS
QD Q1
Quantity of
Gasoline
© 2007 Thomson South-Western
How Price Floors Affect Market Outcomes
• When the government imposes a price floor,
two outcomes are possible.
• The price floor is not binding if set below the
equilibrium price.
• The price floor is binding if set above the
equilibrium price, leading to a surplus.
© 2007 Thomson South-Western
Figure 4 A Market with a Price Floor
(a) A Price Floor That Is Not Binding
Price of
Ice-Cream
Cone
Supply
Equilibrium
price
$3
The government
says that icecream cones must
sell for at least $2;
this legislation is
ineffective at the
current market
price.
Price
floor
2
Demand
0
100
Equilibrium
quantity
Quantity of
Ice-Cream
Cones
© 2007 Thomson South-Western
Figure 4 A Market with a Price Floor
(b) A Price Floor That Is Binding
Price of
Ice-Cream
Cone
Supply
Surplus
$4
Price
floor
3
Equilibrium
price
Demand
0
Quantity of
Quantity Quantity Ice-Cream
Cones
demanded supplied
© 2007 Thomson South-Western
80
120
How Price Floors Affect Market Outcomes
• A price floor prevents supply and demand from
moving toward the equilibrium price and
quantity.
• When the market price hits the floor, it can fall
no further, and the market price equals the floor
price.
© 2007 Thomson South-Western
How Price Floors Affect Market Outcomes
• A binding price floor causes . . .
• a surplus because QS > QD.
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CASE STUDY: The Minimum Wage
• An important example of a
price floor is the minimum
wage.
• Minimum wage laws dictate
the lowest price possible for
labor that any employer may
pay.
© 2007 Thomson South-Western
Figure 5 How the Minimum Wage Affects the Labor Market
Wage
Labor
Supply
Equilibrium
wage
Labor
demand
0
Equilibrium
employment
Quantity of
Labor
© 2007 Thomson South-Western
Figure 5 How the Minimum Wage Affects the Labor Market
Wage
Labor surplus
(unemployment)
Labor
Supply
Minimum
wage
Labor
demand
0
Quantity
demanded
Quantity
supplied
Quantity of
Labor
© 2007 Thomson South-Western
Summary
• Price controls include price ceilings and price
floors.
• A price ceiling is a legal maximum on the
price of a good or service.
– An example is rent control.
• A price floor is a legal minimum on the price
of a good or a service.
– An example is the minimum wage.
© 2007 Thomson South-Western