ECON 101 - Chap. 3.4: Price Ceilings and Price Floors

Price Ceiling

• maximum price seller can ask for their products

• Intended to protect low-income consumers

• Can be see in basic markets (food and shelter)

• Only effective if it is lower than the equilibrium price

• Often create shortages due to lower prices creating higher quantity demanded and lower quantity supplied

Price Controls

• laws that governments enact to regulate prices

• Includes price floor and price ceilings

• What many economists believe are inefficient or harmful

Price Floor

• lowest price one can pay for a good or service

• Keeps the price for falling under an established amount

• Installed to protect producers, such as farmers, for making large losses when market prices fall too much

• Often higher than the equilibrium price

• Allows the quantity supplied to exceed the quantity demanded

Tax Burden

• Burden on Consumers = Consumer Price - Equilibrium Price

• Burden on Producers = Equilibrium price - Producer Price

Elasticity and the Tax Burden

• Elasticity: how much quantity changes when the price change

• Steep demand/supply curve = inelastic

• Flat demand/supply curve = elastic

Tax Incidence

• Distribution of tax burden between consumer and producer

• Irrelevant who is legally responsible for paying the tax; incidence ends up being the same

• Incidence depends only on elasticities

• When demand curve shifts to left, consumer pays

• When supply curve shifts to left, seller pays

• Tax burden is divided unequally between buyer and seller

Consumer Surplus

• amount that individuals would have been willing to pay minus the amount that they actually paid

• Area above market price and below demand curve

• Extra benefit consumers get by paying less than their maximum price

Producer Surplus

• price the producer actually received minus the price the producer would have been willing to accept for each unit sold

• Profit sellers gain by receiving more than their minimum acceptable price

Surplus

Social Surplus/Economic Surplus/ Total Surplus = Consumer Surplus + Producer Surplus

Deadweight Loss

Loss in social surplus that occurs when a market produces an inefficient quantity

• occurs in both price floors and ceilings

Summing Up - Free Market vs. Competitive Market

• demand as willlingness to pay or consumer benefit

• Supply as the cost of each extra unit produced

• Demand vs. Quantity demanded

• Factors that shift demand and supply

Summing Up - Analyzing Policies in a demand and supply model

• Price Controls

• Tax incidence

• Efficiency: consumer/producer surplus, social (total) surplus, deadweight loss