Mod 4 - Lesson 13 - Price Controls - Principles of Economics – D089 PDF

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Lesson 13: Price Controls Lesson Introduction: Controversy sometimes surrounds the prices and quantities established by demand and supply, especially for products that are considered necessities. In some cases, discontent over prices turns into public pressure on politicians, who may then pass legislation to prevent a certain price from climbing too high or falling too low. Laws that a government enacts to regulate prices are called price controls.

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There are two types of price controls:  

PRICE CEILING keeps a price from rising above a certain level (the ceiling). PRICE FLOOR keeps a price from falling below a given level (the floor).

PRICE CEILING: A mandated maximum amount a seller is allowed to charge for a product or service. Examples: Usually set by law, price ceilings are typically applied only to staples such as food and energy products when such goods become unaffordable to regular consumers.

PRICE FLOOR: A government- or group-imposed price control or limit on how low a price can be charged for a product, good, commodity, or service. A price floor must be higher than the equilibrium price in order to be effective. Examples: The government setting the minimum hourly rate that can be paid for labor.

These laws are enacted for the purpose of solving a perceived problem, price controls— either price ceilings or price floors—often have unanticipated side effects.

Lesson 13: Price Controls PRICE CEILING:   

A price ceiling is a price control that limits the maximum price that can be charged for a product or service. Generally, ceilings are set by governments, although groups that manage exchanges can set ceilings as well. By establishing a maximum price, a government wants to ensure the good is affordable for as many consumers as possible.

The purpose of a price ceiling is to protect consumers of a certain good or service.      

A price ceiling will only impact the market if the ceiling is set below the free-market equilibrium price. This is because a price ceiling above the equilibrium price does not limit the market's movement toward equilibrium. The product is sold at the equilibrium price both before and after the ceiling is imposed. When the ceiling is less than the equilibrium price, normal market clearing price adjustment is prevented. The price ceiling causes market failure by reducing the number of exchanges that take place. Imposing the price ceiling reduces the reward to selling, firms bring fewer products to the market.

Lesson 13: Price Controls Price Quantity Demanded Quantity Supplied $1 50 10 $2 40 20 $3 30 30 $4 20 40 $5 10 50 In the table, the market reaches equilibrium at a price of $3. At this price, both quantities demanded, and quantity supplied are 30 units per month, and there is no tendency for price to change.

PRICE CEILING set above the free-market equilibrium price:   

Imposing a price ceiling that makes it illegal to charge more than $4 for the product has no effect on the market. Firms would still sell their products for $3. To be effective, the price ceiling must be set below the equilibrium price. In the case presented here, the price ceiling must be below $3 to alter the market outcome.

PRICE CEILING set below the free-market equilibrium price:  

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Creates a shortage and causes market inefficiency. With more people willing to pay to get the good and fewer producers willing to supply the good, a shortage is inevitable: o At a lower price, less of a good will be produced. o At the same time, quantity demanded will increase. Without the price ceiling, market price would rise, eliminating the shortage. Suppose the price ceiling is set at $2. o Though the ceiling allows firms to charge less than $2, the firms would prefer to charge as much as possible. o At the price of $2, consumers want to purchase 40 units per month. Unfortunately, suppliers are only willing to bring 20 units per month to the market. o This creates a shortage of 20 units per month. Prices are not able to rise, so this shortage will persist.

Lesson 13: Price Controls RENT CONTROL: RENT CONTROL LAWS: A government program that places a limit on the amount that a landlord can demand for leasing a home or renewing a lease.   

These price ceilings usually work by stating that landlords can raise rents by only a certain maximum percentage each year. When faced with rising rents, consumers, who are also potential voters, may unite behind a political proposal to hold down the price. Rather than solving the problem, the policy redistributes benefits and generates an inefficient outcome.

Lesson 13: Price Controls PRICE FLOOR PRICE FLOOR: A price control that limits how low a price can be charged for a product or service.   

Generally, floors are set by governments, although groups that manage exchanges can set price floors as well. The purpose of a price floor is to protect producers of a certain good or service. By establishing a minimum price, a government seeks to promote the production of the good or service and ensure that the producers have sufficient resources to go about their work.

Price $1 $2 $3 $4 $5  

Quantity Demanded 50 40 30 20 10

Quantity Supplied 10 20 30 40 50

A price floor will only impact the market if the floor is set above the market equilibrium price. Setting a price floor above the equilibrium price creates a surplus and causes inefficiency.

Lesson 13: Price Controls Minimum Wage The best-known example of a price floor is the minimum wage. About 1% of American workers are actually paid the minimum wage, In this situation, the price floor minimum wage is said to be nonbinding—that is, the price floor is not determining the market outcome.

Lesson 13: Price Controls

Price Supports Price floors are sometimes called a SUBSIDY, or price supports, because they prevent a price from falling below a certain level.

SUBSIDY: A sum of money granted by the government or a public body to assist an industry or business so that the price of a commodity or service may remain low or competitive.

Lesson 13: Price Controls

Arguments for and against Government Price Controls  

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When prices are especially high or when there is a shortage of goods, it can be difficult for people to get what they need at an affordable price. If a pharmaceutical firm is exploiting its market power to charge an extremely high price for its drug, a well-designed price ceiling can limit the firm's power and ensure that the product remains affordable to most of a country's citizens. They redistribute benefits and create either shortages or surpluses....