Government Policy 1: Price Control

Gov. Economic Policy

• Fiscal Policy (by US. Treasury Dept): Very direct, but slow (needs approval from Congress).
• Monetary Policy (by the Federal Reserve): Less direct, but fast.

Price Ceiling

• Definition: A legal maximum on the price at which a good can be sold.
• The price in the market is not allowed to rise above a certain level.

Not Binding Case

• The market price is lower than the price ceiling.
• The price ceiling has no effect.
• Market outcome:
  • p_e = P (market price) = $3/cone
  • Q_e = Q (market quantity) = 100 cones

Binding Case

• The market price is higher than the price ceiling.
• Shortage occurs (Qd > Qs).
• Market outcome:
  • Price ceiling = P (market price) = $2/cone
  • Shortage = Qd - Qs = 125 - 75 = 50 cones

Policy Implication

• When the government imposes a binding price ceiling on a competitive market, a shortage occurs.
• Sellers must allocate scarce goods, which can be inefficient and lead to social costs.
• The government gives sellers market power to allocate scarce goods.

Application of Price Ceiling: Rent Control

Short-run

• Supply of rental housing is perfectly inelastic.
• Demand for rental housing is very inelastic.
• The government controls rental price lower than p_e to help low-income groups by making rental housing more affordable.
• Market outcome:
  • Controlled rent = market price
  • Shortage (Qd > Qs) occurs.
  • Lack of rental housing supply can occur.

Long-run

• The government still controls the rental price lower than p_e.
• Supply of rental housing becomes more elastic.