EC120 Chapter Notes - Chapter 6: Ice Cream, Price Ceiling, Price Floor
9/24/15
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EC120 – CHAPTER : SUPPLY, DEMAND, AND GOV’T POLICIES
CONTROL ON PRICES (ICE CREAM EXAMPLE)
• Ice cream is sold in a competitive market free of gov’t regulations
• The outcome of a free market does not make everyone happy
o Association of IC Eaters complain that the equilibrium price ($3) is
set too high
o Association of IC Makers argue that the equilibrium price is too low
o BOTH of these groups lobby the gov’t to pass laws that control the
price of ice cream, and there is conflict due to two separate wants
• PRICE CEILING: A legal maximum on the price at which a good can be sold
• PRICE FLOOR: A legal minimum on the price at which a good can be sold
HOW PRICE CEILINGS AFFECT MARKETS
• Gov’t can impose a price ceiling of $/cone, which would not be binding
because it is above the equilibrium. The market would naturally force the
economy to the equilibrium
o Therefore, there is no effect on the price or quantity sold
• Gov’t can also impose a price ceiling of $/cone, which is binding because it
is below the equilibrium. S & D move the price towards equilibrium, but
when it hits the ceiling it can go no further.
o QD > QS and there is a shortage
• In a shortage, a method of rationing the product will naturally develop (e.g.
Buyers willing to wait in line for a cone will do so, those who are not will not
get any)
• Price ceiling was meant to help buyers of ice cream, however not all buyers
benefit from the policy.
• Rationing mechanisms that are caused by price ceilings are undesirable
• Free markets ration goods with prices
HOW PRICE FLOORS AFFECT THE MARKET OUTCOMES
• Back to ice cream example
• Association of IC Makers think that a $ equilibrium is too low, so the gov’t
might institute a price floor
• Price floors are another method of attempting to control prices, by imposing
a legal minimum
• A price floor of $2/cone means that the floor is below the equilibrium, and
the market will force the economy towards it without interruption – it is not
binding
• If a price floor is set at $4/cone then the equilibrium is below the floor. As the
market pushes the price towards the equilibrium, the price floor will stop it –
it is binding
o QS > QD and there is a surplus
• Creates undesirable rationing mechanisms (e.g. sellers appeal to the personal
biases of the buyers)
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