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Why Price Controls are Inefficient

  • Price controls

    • legal restrictions on how high or low a market price may go
  • Price ceiling

    • a maximum price sellers are allowed to charge for a good or service
  • Price floor

    • a minimum price buyers are required to pay for a good or service
  • Whether the government tries to legislate price (up or down), there are predictable and unpleasant side effects.


Effective Price Ceiling

  • Effective price ceilings must be below equilibrium price

  • Rent control

    • government attempt in regulating price on apartments

    • Predictable outcome of housing shortage and emergence of black markets

  • Graph

In panel (a), the government imposes a price ceiling of $4. Because the price ceiling is above the equilibrium price of $3, the price ceiling has no effect, and the market can reach the equilibrium of supply and demand. In this equilibrium, quantity supplied and quantity demanded both equal 100 cones. In panel (b), the government imposes a price ceiling of $2. Because the price ceiling is below the equilibrium price of $3, the market price equals $2. At this price, 125 cones are demanded and only 75 are supplied, so there is a shortage of FIGURE 1 A Market with a Price Ceiling 50 cones. Price of Ice-Cream Cone Equilibrium pnce (a) A Price Ceiling That Is Not Binding Price of Ice-Cream Cone Equilibrium price 53 (b) A Price Ceiling That Is Binding Supply IOO Equilibrium quantity Supply Price ceiling Demand Quantity of Ice-Cream Cones Shonage 75 Quantity supplied Quantity demanded Price ceiling Demand Quantity of Ice-Cream Cones


How a Price Ceiling Causes Inefficiency

  • Inefficiently allocation to consumers

    • Those who want an apartment the most do not necessarily get it.

    • At $1000, someone who was willing to pay $2000 may not get the apartment when the price is low.

  • Wasted resources

    • Price ceilings on gas led to shortages and forced millions of American to spend hours waiting in lines at gas stations. OPPORTUNITY COST!
  • Inefficiently low quality

    • Sellers have little incentive to improve the quality of their product.

    • Landlords have a perverse incentive to only meet the bare, minimum requirements


Effective Price Floor

  • Effective price floors must be above the equilibrium price.

  • Minimum wage

    • government attempt in regulating the labor market in order to give workers a "fair" wage

    • Predictable outcome of having surplus of labor (or unemployment)

  • What happens when a price floor on butter is set at $2.00 a pound when the equilibrium is $1.50

    • Predictable, there is a surplus of butter

    • Governments will stash away surplus, give away to schools, export at a loss, simply destroy the excess or pay farmers NOT to product at all.


  • Graph

FIGURE 5 How the Minimum Wage Affects Panel (a) shows a labor market in which the wage adjusts to balance labor supply and labor demand. Panel (b) shows the impact of a binding minimum wage. Because the minimum wage is a price floor, it causes a surplus: The quantity of labor supplied exceeds the quantity demanded. The result is unemployment. the Labor Market Wage Equilibrium wage (a) A Free Labor Market Equilibrium employment (b) A Labor Market with a Binding Minimum Wage Labor supply Labor demand Quantity of Labor Wage Minimum wage Labor surplus (unemployment) Quantity demanded Quantity supplied Labor supply Labor demand Quantity of Labor


How a Price Floor Causes Inefficiency

  • Inefficiently Low Quantity

    • Same impact as a price ceiling in having less quantity of goods bought and sold
  • Wasted Resources

    • Just like families unsuccessfully looking for apartments under a price ceiling, workers won't find jobs in a price floor.
  • Inefficiently high quality

    • Unable to compete for customers for lower prices, airlines provided lavish excesses consumers didn't want


Ineffective price controls

If the equilibrium price of an airline flight from LAX to Heathrow airport is $1,000: what is the impact of a price floor of $800 for a flight? S No IMPACT

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