Price and Quantity Controls Mr. Bordelon AP Economics.

Price and Quantity Controls

Mr. BordelonAP Economics

Price Controls

• Price control. A legal restriction on how high or low a market price may go. Price controls are enacted by governments in response to political pressures from buyers and sellers.– NOTE: This is a political policy affecting the

economy.• Key Assumption: Markets are efficient before

price controls are imposed.

Price Controls

• But why?– Define “fair.”

• Understand that no matter how you define “fair” nor from what perspective, there are predictable and unpleasant side effects.

Repeat

• I look down at the ceiling, but look up at the floor.

Model of a Price Ceiling

Price Ceilings

• Price Ceiling. Maximum price sellers are allowed to charge for a g/s.– Driven by consumers.

• Price ceilings are imposed typically during emergencies: wars, famine, plagues, locusts, basically all the bad parts of Apocalypse, etc.

• If PE is “too high” then a price ceiling (PC)must be set below PE.

• A PC set above PE has no effect. Why?

Tacos!Price per Taco QD Tacos QS Tacos

1 9 1

2 8 2

3 7 3

4 6 4

5 5 5

6 4 6

7 3 7

8 2 8

9 1 9

10 0 10

Equilibrium: QE = 5, PE = $5

Consumers are mad at this high a taco price and lobby for a law that says tacos can be sold for no more than $3. We win, right? Cheap tacos for everyone!

Effects of a Price Ceiling

• Shortage. PC = QD – QS

– If PC = $3, QD = 7 and QS = 3, shortage of 4 tacos.∴

– In theory, consumers are helped by the lower price.– In practice, only those who got the three tacos are

helped.

• Price ceilings ALWAYS cause shortages.


• Inefficient Allocation to Consumers. With a price ceiling, people who want the good and are willing to pay a higher price don’t get it. Those who care less about the good, and are only willing to pay a low price do get it.• Remember, we’re always trying to get back to equilibrium.

When we have a shortage, some buyers are willing to pay a higher price for the good, and drive the price back to equilibrium. With a price ceiling, that doesn’t happen.


• Bobbette happens to be a taco customer. He would not have paid $5 for a taco before the price control, but he got lucky. So he gets the taco a $3.

• Bob is also a taco customer. And the man craves tacos more than life. He would have paid upwards of a whole $10 for a taco, but Bobbette beat him to it.

• This is inefficient. Why?


• Some people could be made better off without making other people worse off.

• Bobbette could sell the taco to Bob for $7 and both win.


• Wasted Resources. People spend money, time and effort in order to deal with shortages caused by the price ceiling.

• Time spent has an opportunity cost. Time spent looking for scarce tacos has an opportunity cost—working, playing, studying, etc. This creates inefficiency to the price control.


• Inefficient low quality. With a PC, sellers will offer low-quality goods, though buyers prefer higher quality, even at a higher price.

• How do I make a low-quality taco? Keep it G-rated.

• Why is this bad?


• Black Market. A market in which g/s are bought and sold illegally—either because it is illegal to sell them at all or because the prices charged are legally prohibited by a price ceiling.

Why Have Price Ceilings At All?

• They do benefit some consumers. Consumers may have political clout to persuade government that PE is taking advantage of them.

• Long term. If a PC is in effect for a while, buyers may not have a realistic idea of what would happen without them.

• Politicians are idiots. Government officials often do not understand supply and demand analysis.

Model of a Price Floor

Price Floors

• Price Floor. A legal minimum price buyers are required to pay for a good.

• Minimum Wage. A legal floor on the wage rate, which is the market price of labor.

• If PE is considered “too low,” a price floor (PF) is set above PE.

• A PF set below PE has no effect. Why?

Tacos!Price per Taco QD Tacos QS Tacos

1 9 1

2 8 2

3 7 3

4 6 4

5 5 5

6 4 6

7 3 7

8 2 8

9 1 9

10 0 10

Equilibrium: QE = 5, PE = $5

Producers are mad at this low a taco price and lobby for a law that says tacos can be sold for no less than $7. Yay, the capitalists pigs win! Right?

Effects of a Price Floor

• Surplus. PF lead to excess supply. QS > QD

• If PF = $7, QS = 7, QD = 3, surplus of 4 tacos.∴

– In theory, sellers helped by the higher price.– In practice, sellers now have extra tacos, because

there are less people willing to buy tacos at $7 than at $5.

• Price floors ALWAYS cause surpluses.


• Inefficient allocation of sales among sellers. Those who would be willing to sell the good at the lowest price are not always those who actually manage to sell it.


• Bob isn’t a very efficient taco chef and can’t sell tacos at $5, but can at $7. He’s lucky enough to get just one of the few buyers.

• Bobbette is very efficient and could sell at $4, but unlucky and doesn’t get a buyer at $7.

• PF has enabled a less efficient to make a sale, and might force an efficient seller out of the market.


• Wasted resources. Government price floors set above PE causes surpluses which the government may be required to buy and destroy.

• Minimum wages result in fewer jobs available and those who’d be willing to work for less waste time searching for a job.

• What about the surplus tacos?


• Inefficiently low quantity. Since a PF raises the price of a good to consumers, QD falls, so the quantity bought and sold falls, creating a loss to society.


• Goods of inefficiently high quality. Sellers offer high-quality goods at a high price, even though buyers would prefer a lower quality at a lower price.

• High price may make tacomakers to provide expensive ingredients that would be unprofitable at lower market price. Would this meet the desires of the average taco-fiend?


• Illegal activity. Price floors encourage bribery of sellers or government officials.

• Minimum wage laws give an incentive to work under the table because there is a surplus of labor willing to work.

Why Have Prices Floors At All?

• They do benefit some producers. Producers may have political clout to persuade government that PE is unfairly low.

• PF create a surplus of the good.• Inefficiencies arising from surplus come in form of

inefficiently low quantity, inefficient allocation of sales among sellers, wasted resources, and an inefficiently high level fo quantity offered by suppliers.

• Incentive for illegal activity: bribery and corruption of government officials.

Quantity Controls

• Quantity control/quota. Upper limit on the quantity of some good that can be bought or sold.

• Why would we want to limit the quantity of a good that can be bought or sold?

• Can you think of any production that is limited?• Who would benefit?

Anatomy of Quantity Controls

• Quotas are set by government.• License. Gives its owner the right to supply a

g/s.

Fish!

• Look at the market for ocean caught salmon.• Equilibrium: QE = 50, PE = $60• Poor salmon. Salmon are so tasty. Salmon are

also endangered. A quota is placed at 40.• Licenses are then allocated, each giving the

salmon boat the right to harvest a certain amount of salmon every year. When the total quota limit is reached, the season is over.

Fish!

• PD: Demand price is price at which consumers will demand that quantity.

• PS: Supply price is price at which producers will supply that quantity.

• Quantity control drives a wedge between PD and PS of a good.

• Quota rent is the difference between PD and PS. Earnings that accrue to license-holder from ownership of right to sell good. It is equal to the market price of the license when licenses are traded.

Fish!• Quota: 40, PD = $80, PS = $50.

Fish!

• If buyers are willing to pay $80, but sellers can produce at cost of $50, each owner of a license to fish salmon earns the difference of $30. This is the amount that a salmon boat would pay for a license.

Costs of Quantity Controls

• Inefficiency. Mutually beneficial transactions don’t occur. Anytime PD at any given quantity is not equal to PS at that quantity, there will be missed opportunities.– Deadweight loss. Lost gains associated with transactions

that do not occur due to market intervention.• Incentives for illegal activities. Suppliers know

additional units could be supplied and buyers could be found. This overproduction violates the quota.– For salmon?

Price and Quantity Controls Mr. Bordelon AP Economics.

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