ECON1101 Chapter Notes - Chapter 4: Price Floor, Economic Equilibrium, Demand Curve

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17 May 2018

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Natasha Warrell

Chapter 4 – Subtleties of the Supply and Demand Model: Price Floors, Price

Ceilings, and Elasticity

Interference with Market Prices: Price Ceilings and Price Floors

• Government imposes two broad types of price controls (ceiling/floor)

Price Control: A government law or regulation that sets or limits the price to be

charged for a particular good

Price Ceiling: A government price control that sets the maximum allowable price for a

good

• Government thinks that the equilibrium price is too high → help consumers

Price Floor: A government price control that sets the minimum allowable price for a

good

• Government thinks that the equilibrium price is too low → help suppliers

Rent Control: A government price control that sets the maximum allowable rent on a

house or apartment

Minimum Wage: A wage per hour below which it is illegal to pay workers

Interference with Market Prices: Side Effects of Price Ceilings

• Price ceilings → prevents firms from charging more than a certain amount for

their products, but if price is below equilibrium price then a shortage is likely

to result

• Persistent shortage = sellers are unwilling to supply as much as buyers want

to buy

Dealing with Persistent Shortages:

• Higher prices not allowed = shortage must be dealt with in other ways

• Methods to manage persistent shortages:

✓ Government can issue a limited amount of ration coupons → do not

exceed the quantity supplied at the restricted maximum price (if not in

place prices will rise)

• Shortage may result in long waiting lines → black markets develop (not

Government related, set prices – used to be typical of command economies)

• Effect: reduction in the quality of good sold – to reduce costs of production

Making Things Worse:

• Price ceilings: can make things worse

E.g. coupons – raises problems about who gets the coupons

E.g. waiting in line – waste of time, black markets

E.g. lower quality of product – both producers and consumers lose

Interference with Market Prices: Side Effects of Price Floors

• Price floor exceeds equilibrium price – surplus will occur

Dealing with Persistent Surplus:

• Government has to buy surplus (farm products) and put into storage → above

equilibrium price – taxpayers money, raises costs to consumers (therefore

avoid price floors on agricultural goods)

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Natasha Warrell

• Gov. reduces supply → telling farms to plant fewer acres/destroy crops

• Minimum wage = e.g. of price floor

✓ Can cause unemployment

✓ Minimum wage exceeds equilibrium wage: no. of workers demanded

at that wage is less than the no. who are willing to work

✓ Surplus of unemployed workers at the minimum wage (people would

work for below minimum wage but employers can not pay them less

than minimum wage)

Making Things Worse:

• Agriculture

✓ Resources allocated to build grain silos (store surplus grain) could be

put to better use

✓ Land (not in use) could be used for house development/high school

sports field

• Usually benefit people that are more well off → suppliers with lots of wealth

and resources

E.g. minimum wage: teenagers from well-off families may end up earning a

higher salary as a result of minimum wage, but a poor parent may lose their

job

Interference with Market Prices: Side Effects of Price Ceilings

Price Elasticity of Demand: The percentage change in the quantity demanded of a

good divided by the percentage change in the price of that good

• Always refers to a particular demand curve or demand schedule – E.g. world

demand for oil

• All other factors that affect demand are held to be constant when price

elasticity is calculated

• Measure of how much the quantity demanded changes when the price

changes – when calculated will be a negative sign (ignore)

E.g. “price elasticity of demand is low” – the quantity of a good changes only

by a small amount when the price changes

Interference with Market Prices: High versus low

• Curve is flat – quantity is very sensitive to price (very elastic)

• Page 81 for graphs

Interference with Market Prices: The Impact of Change in Supply on the Price of Oil

E.g. decline in supply of world oil

• Initially the oil market is in equilibrium (quantity demanded = supplied)

• Reduction in supply of oil (e.g. shutdown of refineries after natural disasters)

= shift to left, less quantity

• Decrease in supply – increase of equilibrium price, decrease equilibrium

quantity

• Elasticity high → even a small increase in the price is enough to get people to

reduce their use of oil and thereby bring the quantity demanded down to the

lower quantity supplied

• Elasticity low → large increase in price is needed to get people to reduce their

use of oil and bring the quantity demanded down to the quantity supplied

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Document Summary

Chapter 4 subtleties of the supply and demand model: price floors, price. Interference with market prices: price ceilings and price floors: government imposes two broad types of price controls (ceiling/floor) Price control: a government law or regulation that sets or limits the price to be charged for a particular good. Price ceiling: a government price control that sets the maximum allowable price for a good: government thinks that the equilibrium price is too high help consumers. Price floor: a government price control that sets the minimum allowable price for a good: government thinks that the equilibrium price is too low help suppliers. Rent control: a government price control that sets the maximum allowable rent on a house or apartment. Minimum wage: a wage per hour below which it is illegal to pay workers. Dealing with persistent shortages: higher prices not allowed = shortage must be dealt with in other ways, methods to manage persistent shortages:

Related Questions

1.) An excise tax on a good typically reduces the net price received by the seller. (TRUE/FALSE)

2.) The burden of an excise tax on gasoline falls entirely on consumers of gasoline. (TRUE/FALSE)

3.) Rent controls are one of the few examples of a price floor in market economies. (TRUE/FALSE)

4.) Imposing a price ceiling below the equilibrium price of a good often leads to_____.

A) A greater supply of the good

B) A black market for the good

C) A rightward shift of the supply curve for the good.

D) A leftward shift of the demand curve for the good.

E) All of these

5.) Which of the following is true of price floors and ceilings?

A) Lead to the same price and quantity as in competitive market.

B) Lead to technical efficiency

C) Cause the demand curve to shift left

D) Usually result from government intervention

E) Cause the supply curve to shift right.

6.) Price ceilings often lead to black markets. (TRUE/FALSE)

7.) When minimum wage is above the equilibrium wage what occurs?

A) There will be a shortage of labor

B) There will be no effect on the number of people employed

C) There will be an increase in unemployment rate

D) There will be a decrease in unemployment rate

8.) An excise tax on a good typically reduces the price paid by the consumer (TRUE/FALSE)

9.) If a price ceiling is below the equilibrium price is imposed on a market, it will cause the quantity demanded to rise and the quantity supplied to fall. (TRUE/FALSE)

10.) Price floors often lead to black markets. (TRUE/FALSE)

11.) If an excise tax is imposed on restaurant meals what occurs?

A) Fewer meals will be produced and sold

B) More meals will be produced and sold

C) Market price of the meals will fall

D) Government tax revenue will fall.

mauveyellowjacket715

"Shortages, price controls, and queuesDuring the late 1980s and early 1990s, economic reforms initiated by Soviet president Mikhail Gorbachev began to raise consumer incomes; however, the Soviet government continued to impose price ceilings on basic goods like food, clothing, and household goods. As higher income led to increased demand, severe shortages of many goods and long lines at all kinds of stores became common. Finally, in January 1992, a new Russian government under president Boris Yeltsin removed retail price controls on most goods. Within a month, prices more than doubled on average, and lines disappeared. Analyze these events using the supply and demand model. First draw a supply and demand diagram for some normal good such as butter. Show the market in equilibrium at a price of 1 ruble per kilo before the beginning of the Gorbachev reforms. Draw a horizontal line at that level to represent the price ceiling; no butter can be sold for more than 1 ruble per kilo. Next show the effect of rising income. Does it shift the supply curve? Does it shift the demand curve? What is the shortage or surplus at the controlled price? After the price control ends, assuming no further shift in the supply and demand curve, what happens to the price? What happens to the shortage or surplus?"

crimsongerbil60

Question 1

During a crisis such as Hurricane Katrina, governments often make it illegal to raise the price of emergency items like flashlights and bottled water. In practice, this means that these items get sold on a first-come, first-served basis. If a person has a flashlight that she values at $5, but its price on the black market is $40, what gains from trade are lost if the government shuts down the black market?

		$30
		$35
		$40
		Indeterminant with the given information.

2 points

Question 2

Which of the following is an example of a price floor?

		A sale price with a limit on the quantity you can purchase.
		Rent-controlled apartments
		Predatory pricing designed to put a competitor out of business.
		The minimum wage

2 points

Question 3

Airline regulation of the 1970s produced a similar result to which of the following government interventions?

		The Affordable Care Act
		Minimum wage laws
		Rent control laws
		Communism

2 points

Question 4

Which of the following is a possible effect of a price ceiling?

		A surplus of the good.
		Increases in product quality.
		Increased gains from trade.
		People will waste time in lines waiting to purchase the good.

2 points

Question 5

What is a price ceiling?

		A minimum price consumers are willing to pay.
		A minimum price allowed by law.
		A maximum price allowed by law.
		A maximum price consumers are willing to pay.

2 points

Question 6

Why are the long lines generated by a shortage worse than paying a higher price in money?

		It is not better or worse. Paying in time and paying in money are essentially the same in a market economy.
		Paying with time reduces the value of money, and prevents valuable trades from occurring.
		Waiting in line is a waste of a valuable resource: time. Paying a price in money transfers the value of resources from one person to another, and maximizes the value of resources.
		Paying with time gives those who do not work an advantage over those who do.

2 points

Question 7

Which of the following is a possible effect of a price floor?

		The quantity supplied exceeds the quantity demanded.
		Increased gains from trade.
		Decreases in product quality.
		A shortage of the good.

ECON1101 Chapter Notes - Chapter 4: Price Floor, Economic Equilibrium, Demand Curve

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