4.3 The Market System as an Efficient Mechanism for Information

Which of the following statements about price controls is true?

Price controls will never cause surpluses or shortages in markets.

Price controls can prevent markets from reaching equilibrium and destroy the links between different markets.

Price controls make the rationing function of markets more efficient.

Price controls cause demand and supply curves to shift, thus having no effect on the rationing function of prices.

Price controls can prevent markets from reaching equilibrium and destroy the links between different markets.

The actions of individual consumers and producers as they react to prices overlap and interlock in markets for goods, labor, and financial capital. A change in any single market is transmitted through these interconnections to other markets. 

The vision of the role of flexible prices helping markets to reach equilibrium and linking different markets together helps to explain why price controls can be so counterproductive. Price controls make prices inflexible and unable to act as transmitters of important information about supply and demand.

The price of hamburger buns, a complement to hamburgers, increases at the same time a drought destroys the feed used for cows. As a result, what will happen to the equilibrium quantity and price of hamburgers? 

In the graph below, move the supply curve, the demand curve, or both, to illustrate how the market for hamburgers changes.

If the price of a good increases, then the demand for its complement good will decrease, in this case the demand for hamburgers will shift to the left, decreasing both the equilibrium price and quantity.

If a drought destroys the feed used for cows, then the supply of feed used for cows will decrease, which will cause the price of feed for cows to increase. Cow feed is an input to raising cows, therefore, the supply of cows will decrease, which will increase the equilibrium price and decrease the equilibrium quantity of hamburger.

The total effect is that the equilibrium quantity of hamburger will decrease, while the equilibrium price of hamburger is unknown.

Which of the following provides a valid explanation for why price controls are often counterproductive? 

• Price controls provide useful information to producers and consumers. 

• Price controls immobilize the price messenger and deprive everyone in the economy of critical information.

• Price controls are not counterproductive because they make it possible for consumers to obtain the goods they need even if they could not afford them at the equilibrium price. 

• Price controls do nothing to affect the underlying forces of demand and supply.

Price controls immobilize the price messenger and deprive everyone in the economy of critical information.

Price controls do nothing to affect the underlying forces of demand and supply.

Prices serve as a remarkable social mechanism for collecting, combining, and transmitting information that is relevant to the market—namely, the relationship between demand and supply—and then act as messengers to convey that information to buyers and sellers.

Thus, price controls stifle important information about the equilibrium level of price and quantity in a market, by making prices inflexible and unable to reach equilibrium. At the same time, price controls do nothing to affect the underlying forces of demand and supply, easily leading to surpluses or shortages in markets. 

The price of baseballs, a complement to baseball bats, increases at the same time the price of aluminum, an input to baseball bats, decreases. How will the equilibrium of baseball bats be affected?

In the graph below, move the supply curve, the demand curve, or both, to illustrate how the market for baseball bats changes.

An increase in the price of baseballs, a complement to baseball bats, decreases demand for baseballs. This shift in demand left will cause both equilibrium price and quantity to decrease.

A decrease in the price of aluminum, an input in the production of baseball bats, increases the supply of baseball bats. This shift in supply right will cause the equilibrium price to decrease but equilibrium quantity to increase.

The total effect is that the equilibrium price of baseball bats will decrease, but the effect on equilibrium quantity is unknown.

A widespread power outage occurs at Kevin & Sons Cinemas at the same time a summer blockbuster movie is released. How will the equilibrium price and quantity of movie tickets be affected?

The equilibrium price of movie tickets rises.

The equilibrium price of movie tickets falls.

The equilibrium quantity of movie tickets rises.

The equilibrium quantity of movie tickets falls.

The equilibrium price of movie tickets rises.

A power outage will decrease the supply of movie tickets which will cause the equilibrium price to increase. At the same time, demand will increase because of a change in tastes and preferences to see a blockbuster film, which will cause equilibrium price to increase. Because both supply and demand cause equilibrium price to increase, the total effect will be for equilibrium price to increase.

A power outage will decrease the supply of movie tickets which will cause equilibrium quantity to decrease. At the same time, demand will increase because of a change in tastes and preferences to see a blockbuster film, which will cause equilibrium quantity to increase. The effect on the equilibrium quantity is unknown due to a simultaneous increase and decrease in equilibrium quantity.