Price Controls

Microeconomics Lecture 9

Price ceiling

a maximum price set by the government, above which a good cannot be bought or sold

Non-binding price ceiling

when a price ceiling is set above the private market equilibrium and it is still legal to charge the equilibrium price 

Binding price ceiling

when the price ceiling is set below the private market equilibrium price and the private market equilibrium price can no longer be legally charged

Binding price ceilings below the equilibrium cause persisting _____ _____

excess demand

When quantity demanded is higher than quantity supplied, which quantity is now the new equilibrium quantity?

quantity supplied (Qs)

To determine which consumers get to purchase the scarce good, we…

ration

Rationing

the act of allocating scarce goods/services/opportunities

Rationing mechanism

an institution that determines the rules for doing so

Under binding price ceilings below the equilibrium production is done by

producers with marginal costs below Pmax

Goods are rationed to consumers with…

the highest willingness to pay (WTP) (textbook assumption)

Consequences of the price ceiling

• Fewer consumers and producers

• Consumers who still buy get a better deal

• Producers who still produce get a worse deal

Under a price ceiling, what happens to surplus?

producer surplus decreases

total surplus decreases

deadweight loss increases

consumer surplus is ambiguous (they lose some consumer surplus but gain a transfer from producer surplus that may or may not make up for the loss)

DWL arises due to a…

reduction in quantity supplied

What could justify DWL and PS to CS transfers in a price ceiling situation?

having a social welfare function (SWF) that puts more weight on CS than PS, and the CS gained being more than the CS lost

What happens to demand and Qd when a price ceiling below the equilibrium price results in wait times?

• Demand falls, the demand curve shifts inward, and WTP falls as wait time rises

• Quantity demanded (Qd) falls and excess demand shrinks because some consumers are not willing to wait (there is still some excess demand)

As wait times continue to increase, what happens to demand and Qd?

the demand curve continues to shift inward, quantity demanded by consumers willing to wait is equal to the quantity supplied (Qd = Qs), new equilibrium as a result

• in this context, wait time adjusts to bring the market equilibrium, instead of the price adjusting like usual

Who is affected by the wait times potentially caused by price ceilings?

• producer surplus is unaffected

• consumers lose a lot of surplus because they had to wait

• Consumers pay two prices: Pmax + Pwait = Ptotal

When non-monetary costs are the rationing mechanism, what happens to surplus?

• Consumer surplus ↓

• Producer surplus ↓

• Total surplus ↓ (DWL ↑)

• No transfers from producers to consumers

Alternative Rationing Mechanisms (other than wait time)

• Lotteries

• Explicit rationing

• Bribery

• Vouchers

True or false? Lotteries have DWL

True. DWL rises due to: Reduced production (similar to textbook case) and Re-allocation (households with high willingness to pay don’t get allocated units!)

Examples of explicit Government/Producer Rationing

The government, or producer, decides who gets to consume at this price through

• arbitrary rule

• connections

• status

Bribery

Consumers pay bribes to producers (or the government) in order to be the ones who get to consume at a low price

Why does bribery cause price ceilings to be ineffective

If consumers can bribe producers in cash, bribes replace prices, and we

return to the original no-price-control equilibrium (no efficiency loss bc ineffective price ceiling)

What happens to DWL in the case of non-transferable vouchers?

High WTP and low WTP households get an equal number of vouchers, leading to Deadweight loss due to misallocation

What happens to DWL in the case of transferable vouchers?

Low WTP households sell their vouchers to high WTP households, resulting in transfers from high WTP households to low WTP households, DWL looks similar to when the government imposes a tax

Price floor

a minimum price set by the government, below which a good cannot be bought or sold

Non-binding price floor

when a price floor is set below the private market equilibrium price and it is still legal to charge the PM equilibrium price

Binding price floor

when the price ceiling is set above the private market equilibrium price and the private market equilibrium price can no longer be legally charged

Binding price floors below the equilibrium cause persisting _____ _____

excess supply (Qs > Qd)

When quantity supplied is higher than quantity demanded, which quantity is now bought and sold?

quantity demanded (Qd)

What is the textbook assumption for which producers sell in a binding price floor situation?

Producers with the lowest cost produce

What is the textbook assumption for what happens to the binding price floor market in terms of surplus, price, and quantity?

• Price ↑

• Quantity ↓

• Consumer surplus ↓

• Deadweight loss ↑

• Producer surplus might rise if producer surplus gained is worth more than lost

Why might DWL rise even higher under price floor conditions?

• Reallocation to high-cost producers

• Rising costs due to non-price competition e.g. advertising

Reallocation to high-cost producers graph

Rising costs due to non-price competition e.g. advertising graph

DWL formula

DWL = TS(Q∗) − TS(QM)

Q∗ (the efficient quantity) vs. QM (the actual quantity produced by the market)

Total surplus formula

1. CS + PS (need to know price)

2. Gross benefits (area under demand) - Total (marginal) costs (area under supply) (don’t need to know price)

The ____ elastic supply is, the greater the excess demand will be

more (there is also a more substantial decrease in Qs)

The ____ elastic demand is, the greater the excess demand will be

more (there is also a more substantial decrease in Qd)

Quota

A regulation that sets the quantity of a good or service provided