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Lecture Note 7

The document discusses price controls, including price ceilings and price floors, which are legal restrictions on market prices aimed at protecting consumers during crises. Price ceilings can lead to shortages and inefficiencies such as wasted resources and black markets, while price floors can result in surpluses and inefficient allocation of sales. Overall, both types of controls create market inefficiencies that affect the quality and availability of goods.

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Amy Shahrier
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4 views17 pages

Lecture Note 7

The document discusses price controls, including price ceilings and price floors, which are legal restrictions on market prices aimed at protecting consumers during crises. Price ceilings can lead to shortages and inefficiencies such as wasted resources and black markets, while price floors can result in surpluses and inefficient allocation of sales. Overall, both types of controls create market inefficiencies that affect the quality and availability of goods.

Uploaded by

Amy Shahrier
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd

Supply, Demand and Government Policies

Dr. Muhammad Shahadat Hossain Siddiquee


Professor, Department of Economics
University of Dhaka
Price Controls
 Are usually enacted when policymakers believe the
market price is unfair to buyers or sellers.
 Price controls are legal restrictions on how high or
low a market price may go.
 This results in government-created price ceilings and
floors.
Price Ceilings & Price Floors

Price Ceiling
A legally established maximum price at which a good
can be sold. A binding price ceiling will be set below
the equilibrium price.
Price Floor
A legally established minimum price at which a good
can be sold. A binding price floor will be set above
the equilibrium price.
Why Price Controls?
• During crisis times, emergencies or wars the
government wants to protect the consumers
from rapidly increasing prices.
• If the equilibrium wage given by supply and
demand for low skilled workers is below poverty
level, the government can set a minimum wage.
Price Controls: Price Ceilings
Price Controls: Price Ceilings...
Price Controls: Price Ceilings...
• Because of these ceilings, we are faced with a
shortage.
• The shortage will lead to inefficiencies:
A market or an economy is inefficient if there are
missed opportunities: some people could be made
better off without making other people worse off.
Price Controls: Price Ceilings...
• Let’s take a look at the different possible
inefficiencies:

1. Inefficient Allocation to Consumers


2. Wasted Resources
3. Inefficiently Low Quality
4. Black Markets
Price Controls: Price Ceilings...
Inefficient Allocation to Consumers
• Price ceilings can lead to inefficiency in the form of
inefficient allocation to consumers: people who
really want the good and are willing to pay a high
price don’t get it, and those who are not so
interested in the good and are only willing to pay a
low price do get it.
• Example: Rent control. In such case people get the
apartment usually through luck or personal
connections.
Price Controls: Price Ceilings...
Wasted Resources
• Price ceilings typically lead to inefficiency in the form
of wasted resources: people spend money, time and
expend effort in order to deal with the shortages
caused by the price ceiling.
• You waste a lot of time looking for a good (e.g. an
apartment) in case of shortage, the time has it’s
value! You can work or just rest, do something better
than look for a good you’ can’t find.
Price Controls: Price Ceilings...
Inefficiently Low Quality
• Price ceilings often lead to inefficiency in that
the goods being offered are of inefficiently low
quality.
• In case of rent controls, the landlords will not
improve the conditions of the apartments, there
is no incentive since the rental fee is low but the
main reason is that since there is a shortage,
people are willing to rent the apartment as it is,
even in bad condition!
Price Controls: Price Ceilings...
Black Markets
• A black market is a market in which goods or
services 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.
• If someone for example bribes (gives extra money) to
the apartment owners he will get the apartment,
but the honest people that don’t break the law will
never find one this way!
Price Controls: Price Floors
• Price Floors: a minimum price buyers are required
to pay for a good. It’s a lower limit for the price.
• The minimum wage is a legal floor on the wage
rate, which is the market price of labor.
Price Controls: Price Floors
Price Floor: Minimum Wage
Price Controls: Price Floors...
Why a Price Floor Causes Inefficiency
• Inefficient Allocation of Sales Among Sellers
Price floors lead to 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.
• Wasted Resources
Like a price ceiling, a price floor generates
inefficiency by wasting resources.
Price Controls: Price Floors...
Inefficiently High Quality and Quantity
Price floors often lead to inefficiency in that goods of
inefficiently high quality are offered: sellers offer
high-quality goods at a high price, even though
buyers would prefer a lower quality at a lower price.
Or, the seller offers more quantity than is demanded
and we are left with a surplus

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