Chapter 5- Price ceilings and Floors

Binding price controls

price ceiling is one that is set below equilibrium price.

Non-Binding Price Controls

not really an economic issue, since it does not affect the equilibrium price.

Price ceiling

legally imposed maximum price on a market

Quality demanded > Quality supplied = a shortage

o Set below equilibrium price (if binding)
o Leads to shortages as quantity supplied is less than quantity demanded
o An example of a price ceiling is a rent control

Price Floor

Legally Imposed minimum Price on a market

o Set above equilibrium price (if binding)

o Leads to surpluses as quantity supplied is greater than quantity demanded
o An example of a price floor is minimum wage

Positive Externality

corrected by subsides or incentives

MC: Marginal Cost

PMB: Private marginal benefit

SMB: Social Marginal Benefit

o Corrected through subsidies/grants/incentives
o Marginal social benefit greater than marginal private benefit

Negative Externality

the imposition of a cost on a party as an indirect effect of the actions of another party. Negative externalities arise when one party, such as a business, makes another party worse off, yet does not bear the costs from doing so.

o Corrected through fines/taxes/fees
o Marginal social cost greater than marginal private cost