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Chapter 6

Chapter 6 EC120.docx

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Wilfrid Laurier University
Peter Sinclair

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.
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