ECON 1 Chapter Notes - Chapter 6: Price Ceiling, Price Floor, Economic Equilibrium
Chapter 6
Controls on prices
Price controls are usually enacted when policy makers think that the market pricce of a good or
service is unfair to buyers or sellers, but these policies may generate inequities on their own.
Price ceiling: a legal maximum on the price at which a good can be sold. (buyers push for this -
so the price canāt go above that)
Price floor: a legal minimum on the price at which a good can be sold. (sellers push for this - so
the price canāt fall below that)
How price ceilings affect market outcomes
Outcome 1: if the price that balances supply and demand is below the price ceiling, the price
ceiling is not binding.
Outcome 2: if the price ceiling is below the equilibrium, the ceiling is a binding constraint on the
market.
The forces of supply and demand tend to move the price toward the equilibrium price BUT when
the market price hits the ceiling, it canāt, by law rise any further. Thus, in this case, market price
equals the price ceiling. The quantity demanded exceeds the quantity supplied and there arises
a shortage.
In response to this shortage some mechanism for rationing (limit) the good will naturally
develop.
- Buyers who are willing to wait a line to get one will get an ice cream, those who do not
wait wonāt get one. Alternatively, sellers could ration ice-cream cones
- Sellers could ration ice cream by selling them according to personal biases, selling to
only friends or relatives etc.
So although a price ceiling was motivated by a desire to help buyers of a certain good, not all
buyers benefit from the policy. While some buyers may benefit from it and pay a lower price,
some might not even be able to have a chance to enjoy the good because of the shortage.
When the government imposes a binding price ceiling on a competitive market, a
shortage of the good arises and sellers must ration the scarce goods among the large
number of potential buyers.
Free, competitive markets ration goods with prices (this is efficient and impersonal). Rationing
mechanisms that develop under the price ceiling are rarely desirable as they are inefficient and
potentially unfair.
How price floors affect market outcomes:
Like price ceilings, price floors are a way to maintain prices other than equilibrium levels. It puts
a legal minimum on the price. Again, 2 outcomes are possible:
Outcome 1: the equilibrium price is above the floor so the price floor is not binding. Market
forces naturally move prices to equilibrium and the price floor has no effect.
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Document Summary
Price controls are usually enacted when policy makers think that the market pricce of a good or service is unfair to buyers or sellers, but these policies may generate inequities on their own. Price ceiling: a legal maximum on the price at which a good can be sold. (buyers push for this - so the price can"t go above that) Price floor: a legal minimum on the price at which a good can be sold. (sellers push for this - so the price can"t fall below that) Outcome 1: if the price that balances supply and demand is below the price ceiling, the price ceiling is not binding. Outcome 2: if the price ceiling is below the equilibrium, the ceiling is a binding constraint on the market. The forces of supply and demand tend to move the price toward the equilibrium price but when the market price hits the ceiling, it can"t, by law rise any further.
