Chapter 4: Price Controls and Quotas: Meddling with Markets

1. Market Intervention: Changing the Nature of the Market

Governments intervene in markets through two main forms of controls:

• Price Controls: Legal restrictions on how high or low a market price may go.

• Quantity Controls (Quotas): Limits on the amount of a good that can be bought or sold.

Why Do Governments Intervene?

• Market prices do not always satisfy buyers or sellers, leading them to lobby the government for intervention.

• Either the equilibrium price is considered too high (e.g., rent) or too low (e.g., wages).

• However, market interference has consequences, often creating inefficiencies and unintended side effects.

2. Price Controls

Types of Price Controls

1. Price Ceiling – A maximum price sellers are allowed to charge for a good or service, typically set below equilibrium.

   • Example: Rent control in NYC, where apartments are capped at $800/month instead of $1,000.

   • Leads to a shortage (quantity demanded > quantity supplied).

   • Consequences of Price Ceilings:

     • Inefficiently low quantity

     • Inefficient allocation to consumers

     • Wasted resources (time and effort)

     • Declining quality (landlords have no motivation to maintain properties)

     • Black markets (illegal renting at higher prices)

     • Deadweight loss – The reduction in market size due to inefficiencies.

   • Example: Venezuela's Food Shortages

     • Price controls intended to help consumers led to severe shortages.

     • Gas stations imposed purchase limits of 10 gallons, leading to long lines and wasted time.

2. Price Floor – A minimum price buyers are required to pay, usually set above equilibrium.

   • Example: Minimum wage laws, agricultural price supports.

   • Binding price floors: When set above equilibrium, they create surpluses (quantity supplied > quantity demanded).

     • Example: The butter market – Demand falls to 9 million pounds, supply rises to 12 million, leading to a 3-million-pound surplus.

   • Consequences of Price Floors:

     • Inefficient allocation of sales among sellers

     • Wasted resources (government stockpiling goods)

     • Inefficiently high quality

     • Black markets (illegal transactions below legal price)

     • Deadweight loss – People who want jobs but can’t find them due to wage floors.

3. Quotas: Government-Imposed Quantity Limits

• A quota is an upper limit on the quantity of a good that can be bought or sold.

• Often used to control supply, stabilize prices, or protect certain industries.

• However, quotas also create inefficiencies, limiting market growth and distorting supply-demand balance.

4. Why Do Price Controls and Quotas Exist?

• Political Influence: Some groups benefit from controls (e.g., renters, farmers) and are more vocal than those harmed.

• Lack of Awareness: Consumers may not realize what would happen without price controls.

• Government Misunderstanding: Policymakers may not fully grasp supply and demand dynamics.

5. Key Takeaways

• Market intervention often causes unintended consequences – shortages, surpluses, inefficiencies, and black markets.

• Price ceilings lead to shortages and declining quality, while price floors create surpluses and wasted resources.

• Quotas limit market size and prevent natural price adjustments.

• Despite their flaws, price controls persist due to political and public pressures.