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Lecture

ECON 208 Lecture Notes - Price Ceiling, Rent Regulation, Price Floor


Department
Economics (Arts)
Course Code
ECON 208
Professor
Sebastien Forte

Page:
of 3
CHAPTER 5: Markets in Action
Partial equilibrium analysis examines a single market in isolation and ignores
feedback effects from other markets
In general, this is appropriate when the specific market is quite small relative to
the entire economy
Most of microeconomics used partial equilibrium analysis
When economists study all markets together they use general-equilibrium
analysis. This is more complication because you are analyzing the whole market
simultaneously
Government controlled prices:
Disequilibirium price:
If the the price is set above equilibrium, producers will want to produce more,
and some sellers will be unable to find buyers (there will be a surplus)
If the price is below equilibrium, some buyers will be unable to find sellers (a
shortage)
With administered prices, the quantity (exchanged) is determined by the lesser
of quantity demanded and supplied
PRICE FLOORS:
Price floors make it illegal to sell the product below the controlled price
Ex) milk quotas
If you put it below the equilibrium it wouldn’t be binding because it wouldn’t be
illegal to charge more, and people would charge the equilibrium
A black market is any market in which goods are sold at illegal prices
A common example of a price floor is the legislated minimum wage- do
minimum wages lead to unemployment?
PRICE CEILINGS:
Shortage- excess demand, surplus- excess supply
A price ceiling is the maximum price at which a product may be exchanged
Ex. Rent control (and you end up with an excess demand)
Typically, a government has one or more of the three main objectives in
imposing a price ceiling: restrict production, keep specific prices down, satisfy
(normative) notions of equity
Rent controls:
Binding rent controls are a specific for of price ceiling. We can use the previous
diagram to predict the effects: a housing shortage, alternative allocation
schemes in black market, illegal schemes like “key money”
Existing tenants in rent controlled apartments win, landlords lose, and potential
future tenants also suffer
Policy alternatives to price ceiling: housing shortages can be reduced if the
government (at the taxpayer’s expense) either subsidizes housing production or
produces public housing directly
The government may also provide lower-income households with income
assistance
No policy is “free” – every policy involved a resource cost
Market efficiency
Legislated minimum wages make firms and some workers worse off, but benefits
those workers who retain this jobs
Rent controls make some tenants better off at the expense of landlords and
harm other tenants
Price corresponding to a specific quantity demanded is the highest price
consumers are willing to payas shown by the height of the demand curve
Price corresponding to a specific quantity supplied is the lowest price producers
are willing to accept- as shown by the height of the supply curve
Price tells us what the quantity demanded is
What is economic surplus? Consumer surplus + producer surplus
Economic surplus is maximized at the competitive equilibrium level of output-
the market is efficient
Market efficiency- the highest economic surplus
05/08/2012:
Price floors- what do you do with the surplus of the goods? If there are no
consumers to buy it, the producers are worse off. Usually the government has to
step in and purchase the extra food. If you don’t do anything with the surplus
the policy and the market break down.
Ex. With the minimum wage, the government stepping in for the surplus of
workers results in something like unemployment insurance.
With a price ceiling, the quantity demanded will not adjust, and there will be a
shortage.
Typically, a government has one or more of three main objectives in imposing a
price ceiling:
o Restrict production
o Keeping specific prices down
o Satisfy (normative) notions of equity
Demand as “value” and supply as “cost”:
o Price corresponding to a specific quantity demanded is the highest price
consumers are willing to pay (as shown by the height of the demand curve).
o Price corresponding to a specific quantity supplied is the lowest price
producers are willing to accept (as shown by the height of the demand
curve).
Cost benefit analysis: how much do you gain vs. how much it costs you
Distance between demand and supply curve (height of demand curve height of
the supply curve) is the benefit to society
Total economic surplus = consumer surplus + producer surplus
Economic surplus is always maximized at the competitive equilibrium level of
output, and the market is efficient
The consumer surplus is defined as area under the demand curve, above the
price
The producer surplus is defined as area above the supply curve underneath the
price
Deadweight loss= the units no longer produced in the market due to the price
floor/ceiling (the net loss to society)
Price floors automatically reduce consumer surplus
Output quotas:
More intuitive than price floors/ceilings
You fix a quantity, and nothing can be produced above that quantity
It must be lower than the equilibrium quantity to be binding
If the price were below what consumers were willing to dear, a black market
would appear
Also has a deadweight loss
Price floor reduces producer and consumer surplus, and a quota does the same
thing. What is the difference?
If demand increases in a quota system, the quantity stays the same then the
price will do up. Any increase in demand will benefit the producer, but not the
consumer. With a price floor, when demand increases, the increase would have
no effect. But if demand goes high enough, it can increase enough to price the
price above the price floor, making it no longer binding, and consumer surplus
will increase (because you value it more but price doesn’t not go up)
Government intervention in competitive markets redistributes surplus between
buyers and sellers, but often creates overall losses. So why do it?
Government policy is often motivated by a desire to help a specific group (ex.
Increases incomes of farmers)
Economics must carefully analyze the effects of such policies to determine the
actual effects rather than what is desirable for political reasons.