Lesson 9: Price Controls

Allocation

involves questions about WHAT goods a society produces and HOW it produces them

Rationing

is concerned with the FOR WHOM question

Why does the questions of allocation and rationing exist?

These questions exist because of scarcity- members of society cannot do everything they would like to do so some options must be chosen at the expense of others

Price system

Rationing system and allocation system

“Market Clearing” Outcome

When prices are unregulated, market forces (S&D) will exert strong and relentless pressure to move the price toward equilibrium. Market is in balance/equilibrium (NO SHORTAGES OR SURPLUSES)

Shortages and Surpluses are

economically inefficient and undesirable

Two Types of Government Price Controls

1. Price Ceiling

2. Price Floor

Government Price Controls

Cases where prices are NOT allowed to freely fluctuate according to market prices, but are fixed above or below the market price due to a efficient market not being equitable (fair); prevents the market from reaching the equilibrium price and quantity

Price ceiling

Government regulation that places an UPPER limit on the price at which a particular good/service/resource may be traded (ex. Rent control, gasoline caps)

To have any effect, where does the ceiling need to be placed with relation to price?

It must be placed BELOW the equilibrium price (a price above the ceiling is illegal; a price below is NOT)

What is the rationale for a price ceiling?

A price ceiling allows consumers to obtain some “essential” good/service that they could not obtain at the equilibrium price because the price was too high

Costs of a Price Ceiling

• 1st Effect (problem): Develops a shortage → creates an allocation problem (unequitable distribution of that good/service)

• People who want the g/s badly and are willing to pay a high price may NOT be the ones to get the g/s… it may go to someone who’s not even willing to pay the market price

Methods to allocate limited units

• Lottery (random selection)

• First come, first served

• Favoritism/ Personal Attributes

• Black Markets

• Contest/Competition

• Need

• Majority Rule (Vote)

• Rationing (equal shares)

• Tradition

Goal of Rent Controls

• Meant to protect low-income families from rising rent prices caused by perceived housing shortages- however they actually create such shortages

• intended to make housing affordable to the poor

Economic effect of Rent Control on Demand Side

Quantity Demanded increases and will continue to be high as long as the ceiling is in place and the price is below market

Economic effect of Rent Control on Supply Side

The lower price makes it less appealing to rent units

• Short run: owners may leave the market; sell units or convert them to condos

• Long run: growth of rental units will remain low and buildings may get rundown as owners neglect them.. could even turn into slums. Investors would rather put their money into real estate without rent controls (ex. office buildings, shopping malls)

Rent controls

disort market signals resulting with misallocated resources- too little resources are being allocated to rental housing and too many are allocated to other uses

Price floor

Government regulation that imposes a LOWER limit on the price at which some good/service/resource may be traded (ex. minimum wage laws; agricultural price supports)

To have any effect, where does the floor need to be placed with relation to price?

It must be set ABOVE the market equilibrium price (price below the floor is illegal; a price above is NOT)

What is the Rationale for a price floor?

To protect the welfare of certain suppliers by maintaining a higher price and thus maintain a sufficient income

Costs of a Price floor

• 1st effect (problem): a surplus → creates an allocation problem

• More quantity supplied than quantity demanded (for labor)- this distorts resource allocation (it’s inefficient)

Goal of minimum wage

to maintain a higher wage so workers have sufficient income

Economic Effects of Minimum Wage

• Surplus of workers creates higher unemployment rates

• There’s some inflation as employers raise prices to cover additional costs

• There’s increased search activity as more people search for work

• It may create some discrimination

• Black Markets

Effect of Price ceilings

Although theyre usually imposed to help buyers, they only help buyers who are actually able to buy (get) the good at the mandated lower price while hurting any buyer NOT able to get the good due to the shortage, especially if they are willing to pay at market price

Effect of Price floor

Although theyre usually imposed to help sellers, they only help sellers/suppliers who are able to “sell” the g/s or resource at the higher mandated wage while hurting any supplier/seller NOT able to sell the g/s or resource, especially those willing to sell for a low price