1 1 lesson overview ba 210 lesson i.6 price and quantity controls chapter 5 price and quantity...

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Lesson OverviewLesson Overview

BA 210 Lesson I.6 Price and Quantity Controls

Chapter 5 Price and Quantity ControlsChapter 5 Price and Quantity ControlsWhy Governments Control PricesWhy Governments Control PricesPrice CeilingsPrice CeilingsHow Price Ceilings Cause InefficiencyHow Price Ceilings Cause InefficiencySo Why are there Price Ceilings?So Why are there Price Ceilings?Price FloorsPrice FloorsHow Price Floors Cause InefficiencyHow Price Floors Cause InefficiencyQuantity ControlsQuantity ControlsControversy: Minimum WagesControversy: Minimum WagesSummarySummaryReview QuestionsReview Questions

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Why Governments Control PricesWhy Governments Control Prices

• The market price moves to the level at which the quantity The market price moves to the level at which the quantity supplied equals the quantity demanded. But this equilibrium supplied equals the quantity demanded. But this equilibrium price does not necessarily please all buyers or all sellers.price does not necessarily please all buyers or all sellers.

• Therefore, the government intervenes to regulate prices by Therefore, the government intervenes to regulate prices by imposing price controls, which are legal restrictions on how imposing price controls, which are legal restrictions on how high or low a market price may go.high or low a market price may go.

• Price ceiling is the maximum price sellers are allowed to Price ceiling is the maximum price sellers are allowed to charge for a good or service.charge for a good or service.

• Price floor is the minimum price buyers are required to pay for Price floor is the minimum price buyers are required to pay for a good or service.a good or service.

Why Governments Control PricesWhy Governments Control Prices


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• 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.

Price CeilingsPrice Ceilings


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The Market for Apartments in the Absence of Government Controls

1.6 1.70 1.8 1.9 2.0 2.22.1 2.3 2.4

$1,400

1,300

1,200

1,100

1,000

900

800

700

600

Quantity of apartments (millions)

Monthly rent (per apartment)

D

E

S

$1,400

1,300

1,200

1,100

1,000

900

800

700

600

2.4

2.3

2.2

2.1

2.0

1.9

1.8

1.7

1.6

1.6

1.7

1.8

1.9

2.0

2.1

2.2

2.3

2.4

Quantity supplied

Quantity demanded

Monthly rent (per apartment)

Quantity of apartments(millions)



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1.60 1.8 2.0 2.2 2.4

$1,400

1,200

1,000

800

600


Monthly rent(per apartment)

D

S

E

BA

Housing shortageof 400,000 apartmentscaused by

price ceiling

Price ceiling

The Effects of a Price Ceiling



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How Price Ceilings Cause Inefficiency How Price Ceilings Cause Inefficiency

• Inefficiently Low QuantityInefficiently Low Quantity Deadweight loss is the loss in total surplus that occurs Deadweight loss is the loss in total surplus that occurs

whenever an action or a policy reduces the quantity whenever an action or a policy reduces the quantity transacted below the efficient market equilibrium quantitytransacted below the efficient market equilibrium quantity

It is the guaranteed minimum loss from a price ceiling.It is the guaranteed minimum loss from a price ceiling. Three other types of loss are likely.Three other types of loss are likely.

• Inefficient Allocation to CustomersInefficient Allocation to Customers

• Wasted ResourcesWasted Resources

• Inefficiently Low QualityInefficiently Low Quality



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1.60 1.8 2.0 2.2 2.4

$1,400

1,200

1,000

800

600


Monthly rent (per

apartment)

D

S

E

Deadweight loss from fall in number

of apartments rented

Price ceiling

Quantity supplied with rent control

Quantity supplied without rent control

A Price Ceiling Causes Inefficiently Low Quantity First, assume only consumers with most value get the good.



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Winners and Losers from Rent Control

1.60 1.8 2.0 2.2 2.4

$1,400

1,200

1,000

800

600

Monthly rent(per

apartment)S

D

E

Consumer surplus

Producer surplus

(a) Before Rent Control

0 1.6 1.8 2.0 2.2 2.4

$1,400

1,200

1,000

800

600

S

D

EPrice ceiling

(b) After Rent Control

Deadweight loss

Producer surplus

Consumer surplus transferred from

producers

Monthly rent(per

apartment)

Quantity of apartments (millions) Quantity of apartments (millions)

Consumer surplus



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• Price ceilings often lead to inefficiency in the form of Price ceilings often lead to inefficiency in the form of inefficient allocation inefficient allocation to consumers: some people who are to consumers: some people who are willing to pay the highest prices don’t get it, and those only willing to pay the highest prices don’t get it, and those only willing to pay less do get it.willing to pay less do get it.

If Abe is willing to pay $1,300 for an apartment but does not 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, 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. there is $200 lost surplus, in addition to deadweight loss.

• Price ceilings typically lead to inefficiency in the form of Price ceilings typically lead to inefficiency in the form of wasted resources: potential expend money, effort and time to be wasted resources: potential expend money, effort and time to be able to buy at the low ceiling prices.able to buy at the low ceiling prices.

• If Abe is willing to pay $1,300 for an apartment and Burt is 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 only $1,100 and does get it, then Abe is willing to pay up to $200 more than Burt in money, effort willing to pay up to $200 more than Burt in money, effort and time to be able to buy at the low ceiling prices.and time to be able to buy at the low ceiling prices.


How Price Ceilings Cause Inefficiency

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• 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.



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• 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.



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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!


So Why are there Price Ceilings?

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• 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.


Price Floors

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The Market for Butter in the Absence of Government ControlsThe Market for Butter in the Absence of Government Controls

$1.40

$1.30

$1.20

$1.10

$1.00

$0.90

$0.80

$0.70

$0.60

14.0

13.0

12.0

11.0

10.0

9.0

8.0

7.0

6.0

8.0

8.5

9.0

9.5

10.0

10.5

11.0

11.5

12.0

Quantity of butter(millions of pounds)

Price of butter(per pound)

Quantity supplied

Quantity demanded

Quantity of butter (millions of pounds)

6 70 8 9 10 11 1312 14

$1.40

1.30

1.20

1.10

1.00

0.90

0.80

0.70

0.60

Price of butter (per

pound)

D

S

E


Price Floors

15 15

60 8 9 10 12 14

$1.40

1.20

1.00

0.80

0.60 D

S

E

BA

Butter surplus of 3 million pounds caused

by price floor

Price floor


Price of butter

(per pound)


The Effects of a Price Floor

Price Floors

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• 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


How Price Floors Cause Inefficiency

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60 8 9 10 12 14

$1.40

1.20

1.00

0.80

0.60 D

S

E

Quantity demanded with

price floor

Quantity demanded without price floor

Deadweight loss

Price floor


Price of butter

(per pound)


A Price Floor Causes Inefficiently Low QuantityFirst, assume only suppliers with lowest cost supply the good.


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• Price floors lead to inefficient allocation of sales among Price floors lead to inefficient allocation of sales among sellers: those who would be willing to sell the good at the sellers: those who would be willing to sell the good at the lowest price are not always those who actually manage to sell lowest price are not always those who actually manage to sell it.it.

• If Abe’s cost to sell butter is $0.60 but does not get to sell, 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, 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. there is $0.20 lost surplus, in addition to deadweight loss.

• Price floors often lead to inefficiency in that goods of Price floors often lead to inefficiency in that goods of inefficiently high quality are offered: sellers offer high-quality inefficiently high quality are offered: sellers offer high-quality goods at a high price, even though buyers would prefer a goods at a high price, even though buyers would prefer a lower quality at a lower price.lower quality at a lower price.

• Likewise, to complete for buyers, Abe may advertise his Likewise, to complete for buyers, Abe may advertise his butter at a significant cost, which is lost surplus in addition butter at a significant cost, which is lost surplus in addition to deadweight loss.to deadweight loss.



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• 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.


Quantity Controls

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6 7 90 8 10 11 1312 14

$7.00

6.50

6.00

5.50

5.00

4.50

4.00

3.50

3.00 D

S

E

Quantity of rides (millions per year)

Fare

(per ride)

14

13

12

11

10

9

8

7

6

6

7

8

9

10

11

12

13

14

Quantity of rides(millions per year)

Fare(per ride)

Quantity supplied

Quantity demanded


The Market for Taxi Rides in the Absence of Government The Market for Taxi Rides in the Absence of Government ControlsControls

Quantity Controls

$7.00

$6.50

$6.00

$5.50

$5.00

$4.50

$4.00

$3.50

$3.00

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$7.00

$6.50

$6.00

$5.50

$5.00

$4.50

$4.00

$3.50

$3.00

14

13

12

11

10

9

8

7

6

6

7

8

9

10

11

12

13

14

Quantity of rides(millions per year)

Fare(per ride)

Quantity supplied

Quantity demanded

A

B

6 70 8 9 10 11 12 13 14

$7.00

6.50

6.00

5.50

5.00

4.50

4.00

3.50

3.00D

S

E

Deadweight loss

The wedge

Quota

Quantity of rides (millions per year)


Fare

(per ride)

Effect of a Quota on the Market for Taxi Rides

Quantity Controls

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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.


Quantity Controls

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The Costs of Quantity Controls

• Deadweight loss because some mutually beneficial transactions don’t occur.

• Incentives for illegal activities.


Quantity Controls

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Controversy: Minimum WagesControversy: Minimum Wages



25 25BA 210 Lesson I.6 Price and Quantity Controls

A minimum wage A minimum wage is the lowest hourly, daily or monthly wage is the lowest hourly, daily or monthly wage that employers may legally pay to employees or workers. that employers may legally pay to employees or workers. Equivalently, it is the lowest wage at which workers may sell Equivalently, it is the lowest wage at which workers may sell their labor. Although minimum wage laws are in effect in a great their labor. Although minimum wage laws are in effect in a great many jurisdictions, there are differences of opinion about the many jurisdictions, there are differences of opinion about the benefits and drawbacks of a minimum wage. Supporters of the benefits and drawbacks of a minimum wage. Supporters of the minimum wage say that it increases the standard of living of minimum wage say that it increases the standard of living of workers and reduces poverty. Opponents say that if it is high workers and reduces poverty. Opponents say that if it is high enough to be effective, it increases unemployment, particularly enough to be effective, it increases unemployment, particularly among workers with very low productivity due to inexperience or among workers with very low productivity due to inexperience or handicap, thereby harming lesser skilled workers to the benefit of handicap, thereby harming lesser skilled workers to the benefit of better skilled workers.better skilled workers.


26 26BA 210 Lesson I.6 Price and Quantity Controls

Question: Question: Use demand and supply curves to show the following Use demand and supply curves to show the following surplus looses from minimum wages designed to help surplus looses from minimum wages designed to help unproductive workers:unproductive workers:

the lost producer surplus from the inefficient allocation of the lost producer surplus from the inefficient allocation of employment (some with higher opportunity costs are employed employment (some with higher opportunity costs are employed while other potential workers with lower costs are not while other potential workers with lower costs are not employed)employed)

the lost total surplus as minimum wages reduce employment.the lost total surplus as minimum wages reduce employment.

the wasted resources from potential workers competing for the wasted resources from potential workers competing for employment.employment.


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Answer: The lost producer surplus Answer: The lost producer surplus if some with higher costs if some with higher costs supply labor while others with lower costs do not sell labor.supply labor while others with lower costs do not sell labor.

S

D

ELoss in producer surplus

if Yvonne successfully competes to sell labor

instead of Xavier

1,000

$6

$7

$5

0 Quantity of labor

Y

X


Minimum wage


28 28

60 8 9 10 12 14

$1.40

1.20

1.00

0.80

0.60 D

S

E

Labor demanded with minimum

wage

Labor demanded without minimum

wage

Deadweight loss

Minimum wage

Employment of labor (millions of hours)

Wage rate(per hour)


The lost total surplus from reduced employment.


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S

D

E

1,000

$60

$70

$50

0 Quantity of labor (days)


Minimum wage

800

The wasted resources The wasted resources of each unit of labor if they compete for of each unit of labor if they compete for jobs by waiting in line for each unit of employment. Only the jobs by waiting in line for each unit of employment. Only the first 800 units are employed, and they each pay $20 to compete first 800 units are employed, and they each pay $20 to compete for employment. for employment.


30 30

S

D

E

1,000

$60

$70

$50

0 Quantity of labor (days)


Minimum wage

800

Comment: Comment: If each unit of labor competes by waiting in line for If each unit of labor competes by waiting in line for each unit of employment, each pays $20 to compete and so is 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 paid the minimum $70 but nets only $50, which is less than if there were no minimum wage. there were no minimum wage.


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SummarySummary

1.1. Even when a market is efficient, governments often Even when a market is efficient, governments often intervene to pursue greater intervene to pursue greater fairnessfairness (although putting needy (although putting needy people on welfare would be more effective) or to please a people on welfare would be more effective) or to please a powerful interest group. Interventions can take the form of powerful interest group. Interventions can take the form of price controls or quantity controls, both of which generate price controls or quantity controls, both of which generate predictable and undesirable side effects.predictable and undesirable side effects.


Summary

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SummarySummary

2.2. A A price ceilingprice ceiling, a maximum market price below the , a maximum market price below the equilibrium price, benefits successful buyers but creates equilibrium price, benefits successful buyers but creates persistent shortages. Price ceilings lead to inefficiencies in persistent shortages. Price ceilings lead to inefficiencies in the form of deadweight loss from inefficiently low quantity, the form of deadweight loss from inefficiently low quantity, inefficient allocation to consumers, wasted resources, and inefficient allocation to consumers, wasted resources, and inefficiently low quality. It also encourages illegal activity inefficiently low quality. It also encourages illegal activity (tempting citizens to break the law) as people turn to black (tempting citizens to break the law) as people turn to black markets to get the good.markets to get the good.


Summary

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SummarySummary

3.3. A A price floorprice floor, a minimum market price above the equilibrium , a minimum market price above the equilibrium price, benefits successful sellers but creates persistent price, benefits successful sellers but creates persistent surplus. Price floors lead to inefficiencies in the form of surplus. Price floors lead to inefficiencies in the form of deadweight loss from inefficiently low quantity, inefficient deadweight loss from inefficiently low quantity, inefficient allocation of sales among sellers, wasted resources, and allocation of sales among sellers, wasted resources, and inefficiently high quality. It also encourages illegal activity inefficiently high quality. It also encourages illegal activity and black markets. The most well-known kind of price floor and black markets. The most well-known kind of price floor is the minimum wage, but price floors are also commonly is the minimum wage, but price floors are also commonly applied to agricultural products.applied to agricultural products.


Summary

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SummarySummary

4.4. Quantity controlsQuantity controls, or quotas, limit the quantity of a good that , or quotas, limit the quantity of a good that can be bought or sold. The quantity allowed for sale is the can be bought or sold. The quantity allowed for sale is the quota limit. The government issues licenses to individuals, quota limit. The government issues licenses to individuals, the right to sell a given quantity of the good. Economists say the right to sell a given quantity of the good. Economists say that a quota drives a wedge between the demand price and that a quota drives a wedge between the demand price and the supply price; this wedge is equal to the quota rent. the supply price; this wedge is equal to the quota rent. Quantity controls lead to deadweight loss in addition to Quantity controls lead to deadweight loss in addition to encouraging illegal activity.encouraging illegal activity.


Summary

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Review QuestionsReview Questions


Review QuestionsReview Questions You should try to answer some of the following questions You should try to answer some of the following questions before the next class. before the next class. You will not turn in your answers, but students may request You will not turn in your answers, but students may request to discuss their answers to begin the next class. to discuss their answers to begin the next class. Your upcoming Exam 1 and cumulative Final Exam will Your upcoming Exam 1 and cumulative Final Exam will contain some similar questions, so you should eventually contain some similar questions, so you should eventually consider every review question before taking your exams.consider every review question before taking your exams.

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Review QuestionsReview Questions


Follow the linkFollow the linkhttp://faculty.pepperdine.edu/jburke2/ba210/PowerP1/Set5Answers.pdffor review questions for Lesson I.6 that practices these skills: for review questions for Lesson I.6 that practices these skills: Identify the effective and ineffective price ceilings and floors.Identify the effective and ineffective price ceilings and floors. Compute the shortage and reduced supply from a price ceiling.Compute the shortage and reduced supply from a price ceiling. Identify the inefficiencies from a price ceiling:Identify the inefficiencies from a price ceiling:

loss from lowered quantity as some previous consumers no longer consume and some loss from lowered quantity as some previous consumers no longer consume and some previous sellers no longer sell,previous sellers no longer sell, an inefficient allocation to consumers (some with higher willingness to pay do not an inefficient allocation to consumers (some with higher willingness to pay do not consume while others with lower willingness to pay consume),consume while others with lower willingness to pay consume), wasted resources from consumers competing to buy,wasted resources from consumers competing to buy, inefficiently low quality.inefficiently low quality.

Compute the surplus and reduced demand from a price floor.Compute the surplus and reduced demand from a price floor. Identify the inefficiencies from a price floor: Identify the inefficiencies from a price floor:

loss from lowered quantity as some previous consumers no longer consume and some loss from lowered quantity as some previous consumers no longer consume and some previous sellers no longer sell,previous sellers no longer sell, an inefficient allocation to producers (some with higher costs produce while others with an inefficient allocation to producers (some with higher costs produce while others with lower costs do not produce),lower costs do not produce), wasted resources from producers competing to sell,wasted resources from producers competing to sell, inefficiently high quality.inefficiently high quality.

Compute the deadweight loss of a quota.Compute the deadweight loss of a quota. Compute the quota rent, as the value of the right to sell under the quota.Compute the quota rent, as the value of the right to sell under the quota.

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End of Lesson I.6End of Lesson I.6


BA 210 Introduction to BA 210 Introduction to MicroeconomicsMicroeconomics

1 1 lesson overview ba 210 lesson i.6 price and quantity controls chapter 5 price and quantity...

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