Price Controls Study Notes
Policy Levers: Price Controls
Introduction to Price Controls
Price controls refer to policies that impose legal limits on the market prices of particular goods or services. They are implemented by governments for several reasons, including:
To assist disadvantaged groups.
To manage the affordability of certain goods.
To curry favor with important interest groups.
Types of Price Controls
Price controls can be categorized into two main types:
Price Floors
A price floor establishes a minimum price that can be charged for a good or service.
Prices below the established floor are illegal and subject to fines.
Examples:
Agricultural price supports
Minimum wage laws
Price Ceilings
A price ceiling establishes a maximum price that can be charged for a good or service.
Prices above the ceiling are illegal and subject to fines.
Examples:
Price-gouging laws
Rent control
The Transitional Gains Trap
The transitional gains trap refers to the issue where some groups benefit from the price controls, which creates a barrier to the adjustment of policies and leads to inefficiency in the market.
The Algebra of Price Controls
Understanding the economic implications of price controls requires an analysis of their effects on market price and quantity.
Effects of a Binding Price Floor
A binding price floor is effective when it is set above the equilibrium price.
Example:
If the market equilibrium price is $5.50 and a price floor is set at $7.00, quantity demanded (QD) would decrease to 4.5 units, while quantity supplied (QS) would increase to 6 units.
In this case, the market price is artificially raised to $7.00, leading to a surplus in the market.
Effects on Total Surplus
With a binding price floor:
Consumer Surplus (CS), Producer Surplus (PS), Total Surplus (TS), and Deadweight Loss (DWL) can be illustrated as follows:
CS: $10.13 when prices are at floor
PS: $10.13 when prices are at floor
TS: $20.25 initially, drops to $18.00
DWL: $2.25
Effects of a Non-binding Price Floor
A non-binding price floor is set below the equilibrium price.
Example:
If the market equilibrium price is $5.50 and a price floor is set at $3.00, QD equals QS at 4.5 units.
In this case, the market operates naturally with no illegal ramifications.
Effects on Total Surplus with Non-binding Floor
In this scenario, there is no change in total surplus:
CS: $10.125
PS: $10.125
TS: $20.25 unchanged
DWL: $0.00
Surplus Elimination
Sellers could sell surplus goods on the black market, often resulting in a higher underground price, which in this example would be $4 per unit.
Binding Price Ceilings
A binding price ceiling is effective when set below the market equilibrium price.
Example:
A price ceiling at $3.00 leads to QD at 4.5 and QS at only 2 units, creating a shortage in the market.
Total Surplus with Binding Price Ceiling
When a binding price ceiling is applied:
CS may rise to $12.00
PS drops to $2.00
TS decreases from $20.25 to $14.00
DWL rises to $6.25
Non-binding Price Ceilings
A non-binding price ceiling is set above the equilibrium price without causing shortages.
Example:
If a price ceiling is set at $8.00, both QD and QS remain at 4.5 units, thereby keeping the market stable.
Total Surplus with Non-binding Ceiling
In this case, total surplus is maintained:
CS: $10.125
PS: $10.125
TS: $20.25 remains unchanged
DWL: $0.00
Coping with Shortages under Price Ceilings
Buyers impacted by shortages often cope by either waiting, going without the goods, or purchasing goods from the black market at inflated prices, such as $8 per unit.
Case Study: Rent Control
The objective of implementing a price ceiling on rental units is to make housing more affordable.
However, consequences include:
A decrease in available rental units due to limited new construction, landlords converting units to more profitable uses, and current tenants remaining longer, decreasing turnover.
Illegal subletting where units may be rationed based on willingness to pay, not need, often resulting in black market prices.
Other unintended consequences like downgrading of unit quality and the emergence of practices such as key money or ambulance chasing.
Expert Opinions on Rent Control
Notably, economist Assar Lindbeck stated, "In many cases rent control appears to be the most efficient technique presently known to destroy a city—except for bombing." The general consensus illustrates that binding rent control policies, while aiming to aid impoverished tenants, often yield the opposite effect, resulting in market inefficiencies.
Long-term Effects of Binding Rent Control
A binding rent control policy will likely lead to a decrease in the rental-housing shortage over time.
Case Study: Oregon Rent Control Legislation
In 2019, Oregon enacted statewide rent control limiting annual rent increases to 7%.
The effects on rental housing availability include the potential reduction of rental units where pre-regulatory price increases exceed the limit set by the legislation.
Example: Minimum Wages
Minimum wage laws aim to increase living standards for the working poor by setting a price floor on labor.
Federal minimum wage: $7.25 per hour since 2009.
Oregon’s tiered minimum wage (from July 1, 2025):
Portland Metro: currently $16.30 per hour
Standard: currently $15.05 per hour
Non-urban counties: currently $14.05 per hour
Washington State minimum wage (from January 1, 2025):
Seattle: $21.30 per hour
Other areas: $17.13 per hour
These wages are set to increase annually based on the Consumer Price Index (CPI) for All Urban Consumers.
Predictions from Minimum Wage Increases
Economic predictions suggest that increasing minimum wages could lead to:
Higher unemployment rates.
Enhanced benefits for employees retaining their jobs.
Deterioration for those who may lose their jobs as a result of the wage increases.