5.1 The Interaction Among Markets 10-03-2012
No market or industry exists in isolation from the economy’s many other markets.
Feedback – change in one market change in multiple markets
o Assume that the prices of all other goods are constant
Partial equilibrium analysis – analysis of a single market in situations in which the feedback
effect from other markets are ignored
When partial equilibrium analysis is a legitimate method of analysis: when the specific
market is quite small relative to the entire economy.
o Changes in that market will be small; therefore, the effects on other markets
(feedback effect) will be even smaller.
General equilibrium analysis – study all markets together; how events in each market affect all
the other markets
o How all markets function together taking into account the various relationships
and feedback effects. 5.2 Government-Controlled Prices 10-03-2012
Governments fix the price at which a product must be bought and sold
Government price controls – hold the price at some disequilibrium value
o When below its Eq value, shortage
o When above its Eq value, surplus
Voluntary market transaction requires both a willing buyer and a willing seller
In disEq, quantity exchanged is determined by the lesser of Qs and Qd.
Price floor – minimum possible price
Binding – when it’s set above the Eq price
Raise the price
Government guarantees the producers that they will buy any excess supply – usually with
agricultural support (or else population will have nothing to eat if the farmers decide to stop
Binding price floors lead to excess supply (surplus). Either an unsold surplus will
exist or someone (usually government) must enter the market and buy the excess
Consequences of excess supply
o If there’s a surplus of labour (from minimum wage price floor) unemployment
o If there’s a surplus of wheat (agriculture) accumulate in government warehouses
(grain elevators, stock piling)
o Inevitable in a competitive market
Why would the government put up with these consequences?
o Producers could actually be better off with the price floor than if they had to accept the
lower Eq price.
o Workers & farmers are politically active
o Demand of agricultural products is (usually inelastic), so producers earn more
in total (See ch. 4)
Price ceiling – maximum price
Binding – when it is set below the Eq price
Binding price ceilings lead to excess demand (shortage) with the quantity exchanged
being less than in the free market equilibrium. Allocating a Product in Excess Demand
o Adjustment cannot happen with the price ceiling, so there must be another method of
o First come, first served basis – consumers rush to stores, stand in long lines (ex.
Concerts, sporting events)
o Seller’s Preferences – seller sets aside products for family members, friends, etc.
o Rationing of the product – gov’t distributes rationing coupons to match the Qs at the
price ceiling; consumers would need those coupons & the money to purchase the
o Black markets – goods sold illegally at prices that violate the legal price control
o Binding price ceilings always create the potential for a black market because
profit can be made by buying at the controlled price and selling at the black-
Goals Governments Often Have When Imposing A Price Ceiling
o  Restrict production (release close resources for other uses, reallocation of resources)
o  Keep specific prices down
o Satisfy notions of equity in a consumption of a product that’s in short supply
o To the extent that binding price ceilings give rise to a black market, it is likely
that the government’s objectives motivating the imposition of the price ceiling
will be thwarted.
o  If producers can sell illegally above the price ceiling, nothing’s stopping them from
producing more (as long as it’s sold at a price above the price ceiling – which is their
incentive to increasing their production).
o  Actual prices are not kept down when it’s sold on the black market.
o  Products on the black market will probably only be sold to those who can afford
those black market prices (no equity in the distribution). 5.3 Rent Controls: A Case Study of Price Ceilings
Shortages of rental accommodations
Varied short and long term effects
First-generation rent control – holding the price of housing below Eq price
Second-generation rent control – regulating the rental housing market
Predicted Effects of Rent Controls
Housing shortage; Qd > Qs
Alternative allocation schemes – by sellers’ preference, government’s security-of-tenure laws
(protects old tenants from eviction, no place to stay for new tenants)
Black markets – “key money” = Eq price – price ceiling (large security deposits, parking passes,
or monthly dues)
Because apartments are highly durable goods that provide services to consumers