Lecture 5 (Chapter 8) - Price Ceilings and Floors

Price Controls

Definition: Laws that restrict prices from moving above a maximum (price ceilings) or below a minimum (price floors).

Definition: A maximum price allowed by law.
Effects of Price Ceilings:
- Shortages: When price ceiling < market price, demand exceeds supply (Qd > Qs). Greater price difference leads to larger shortages.
- Quality Reductions: Sellers may lower quality/services instead of raising prices to meet demand.
- Wasteful Lines: People willing to pay more are illegal under price controls, often resulting in queues or bribes.
- Lost Gains from Trade: Mutual beneficial trades may not occur, resulting in deadweight loss (consumer surplus + producer surplus loss).
- Misallocation of Resources: Resources allocated ineffectively due to random distribution caused by price constraints.

Definition: Specific price ceiling on rental housing.
Effects:
- Initial rent freeze can lead to lower rents than market equilibrium.
- Long-run implications include fewer new units, older units converted to condominiums, and increased search costs for housing.

Definition: A minimum price allowed by law.
Effects of Price Floors:
- Surpluses: A minimum wage above market wage results in excess supply of labor (unemployment).
- Lost Gains from Trade: Deadweight loss from inability to trade at market wage rates.
- Wasteful Increases in Quality: Price floors can lead to unnecessary quality improvements as businesses compete beyond consumer willingness to pay.
- Misallocation of Resources: Price controls distort resource allocation in a broader market context.

Price Ceilings: Result in shortages, quality reductions, search costs, losses in trade efficiency, and misallocation of resources.
Price Floors: Lead to surpluses, losses in trade efficiency, increased quality costs, and misallocation of resources throughout the economy.