EC120 Chapter 6-Supply, Demand, and Government Policies Week 4
Controls on Prices
-If ice cream is sold in a competitive market, free of government regulation, the price of ice cream
adjusts to balance supply and demand: at equilibrium price, the quantity that buyers want to buy exactly
equals the quantity that sellers want to sell. Suppose the equilibrium price is $3.
-Because buyers of any good want a lower price, while sellers want a higher price, the interests of the
two groups conflict.
-The buyers of the good (Canadian Association of Ice-Cream Eaters) complains that the price is too high
for everyone to enjoy a cone a day –the daily recommendation. The sellers of the good (Canadian
Organization of Ice Cream Makers complain that the $3 price – the result of “cutthroat competition” is
too low and depressing the income of its members
-If the ice cream eaters are successful in their lobbying, the government imposes a legal maximum or the
price at which the ice cream can be sold. Because the price is not allowed to rise above this level, the
legislated maximum is called a price ceiling
-If the ice cream makers are successful the government imposes a legal minimum on the price. Because
the price cannot fall below this level, the legislated minimum is a price floor.
How Price Ceilings Affect Market Outcomes
-If there is a price ceiling above equilibrium, the ceiling balances supply and demand below the ceiling
and that makes the ceiling not binding
-If there is a price ceiling below equilibrium, it is a binding constraint on the market. This leads to a
shortage in supply.
-When a shortage of ice cream develops because of the price ceiling, some mechanism for rationing ice
cream will naturally develop. The mechanism could be long lines.
Case Study: Line at the Gas Pump EC120 Chapter 6-Supply, Demand, and Government Policies Week 4
How Price Floors Affect Market Outcomes
-Price floors, like price ceilings, are an attempt by the government to maintain prices at other than
equilibrium levels. A price floor places a legal minimum
-A binding price floor causes a surplus
-In the case of a price floor, some sellers are unable to sell all they want at market price.
-The sellers who appeal to the personal biases of the buyers, are better able to sell their goods than
those who do not
Case Study: The Minimum Wage
-Minimum wage law dictates the lowest price for labour that any employer can pay
-Workers determine the supply of labour, and firms determined the demand. If the government doesn’t
intervene, the wage normally adjusts to balance labour supply and labour demand.