ECON201_-_Chapter_5

Chapter Overview

• Title: Price Controls and Market Efficiency

• Author: Ragan

• Edition: Seventeenth Canadian Edition

Learning Objectives

5.1 Government-Controlled Prices

• Describe effects of price ceilings and price floors on equilibrium price and quantity.

5.2 Rent Controls: A Case Study of Price Ceilings

• Compare short-run and long-run effects of rent controls.

5.3 Market Efficiency

• Describe relationship between economic surplus and market efficiency.

• Explain inefficiencies caused by price controls and output quotas.

5.1 Government-Controlled Prices

Disequilibrium Prices

• Key Concept: Voluntary market transactions require both buyer and seller participation.

• Supply & Demand Balance:

  • Quantity demanded < quantity supplied: demand sets exchange amount.

  • Quantity demanded > quantity supplied: supply sets exchange amount.

  • In disequilibrium, exchanged quantity is determined by the lesser of demand/supply.

Price Floors

• Definition: Minimum permissible price for goods/services.

• Effect: Leads to excess supply when binding.

• Example: Minimum wage acts as a price floor in labor market.

Application: Minimum Wages and Unemployment

• Consequences:

  1. Employment level decreases.

  2. Quantity of labor supplied increases.

• Result: Increase in unemployment.

• Impact on firms: Higher wage costs affect profits negatively.

Employment Impacts

• Some workers benefit from higher wages while keeping jobs.

• Others may lose their jobs due to minimum wage policies.

5.2 Rent Controls: A Case Study of Price Ceilings

Predicted Effects of Rent Controls

• Binding controls lead to:

  • Shortage of rental housing due to higher demand than supply.

  • Adoption of alternative allocation schemes.

  • Emergence of hidden markets.

Short-Run vs. Long-Run Effects of Rent Controls

• Short-run: Supply remains constant (perfectly inelastic supply curve).

• Long-run: Supply decreases as fewer units are offered, exacerbating shortages.

Case Study: Rent Controls in Ontario

Historical Overview

• 1975: Rent control instituted, limiting rent increases.

• 1990s: Shortage in rental market, particularly acute in Metro Toronto.

• Post-2017: Renewed controls generated backlash; exemptions for new units introduced.

Who Gains and Who Loses?

• Gain: Existing tenants in controlled accommodations.

• Loss: Landlords (reduced returns) and potential future tenants (decreased housing availability).

Policy Alternatives

• Government can subsidize housing production or create public housing to tackle shortages.

• Direct income assistance for lower-income households as another strategy.

• Consideration of resource costs for policies is essential.

5.3 An Introduction to Market Efficiency

• Analyzing effects of controlled prices on society: balance between benefits (to some) and costs (to others).

• Questions of how minimum wage and rent controls affect overall societal welfare.

Demand as "Value"

• The demand curve reveals consumer willingness to pay, illustrating perceived value of goods.

Supply as "Cost"

• The supply curve indicates the minimum acceptable price for producers, reflecting their costs.

Economic Surplus and Market Efficiency

• Total Economic Surplus: Area between demand and supply curves, maximized at free-market equilibrium.

Market Inefficiencies with Price Controls

• Deadweight Loss: Loss of economic surplus due to binding price controls, be it ceilings or floors.

A Cautionary Word

• Government interventions often aim to assist specific groups but lead to broader inefficiencies.

• Economists focus on positive analyses to understand actual policy outcomes, leaving normative judgments to policymakers.

Applying Economic Concepts

Price Gouging Debate

• Extreme events can prompt scarcity; higher prices can lead to efficient resource allocation but spark ethical questions about profit-seeking behavior during crises.