chapter 6 price ceilings and price floors gottheil principles of economics, 7e © 2013 cengage...

Chapter 6Chapter 6

PRICE CEILINGS AND PRICE CEILINGS AND PRICE FLOORSPRICE FLOORS

Gottheil — Principles of Economics, 7e© 2013 Cengage Learning1

Economic PrinciplesEconomic Principles

Government intervention in markets

Price ceilings

Price floors

Parity pricing

Target prices

Crop limitation programs

© 2013 Cengage Learning Gottheil — Principles of Economics, 7e2

EXHIBIT 1 PRODUCTION POSSIBILITIES CURVE FOR CIVILIAN AND DEFENSE GOODS


Exhibit 1: Production Possibilities Exhibit 1: Production Possibilities Curve for Civilian and Defense GoodsCurve for Civilian and Defense Goods


The production possibilities curve in Exhibit 1 provides information on:• The production possibilities curve shows

the possible combination of civilian and defense goods that could be produced.

Exhibit 1: Production Possibilities Exhibit 1: Production Possibilities Curve for Civilian and Defense GoodsCurve for Civilian and Defense Goods


When there is a national security crisis, the number of civilian goods produced: • The production of civilian goods declines

as more defense goods are produced.

EXHIBIT 2 THE FISH MARKET BEFORE AND AFTER THE DRAFT


Exhibit 2: The Market Before Exhibit 2: The Market Before and After the Draftand After the Draft


In Exhibit 2, the community’s predraft and postdraft demand for fish does not change.• Demand for fish doesn’t change just because

there’s a national security problem.



In Exhibit 2, the community’s predraft and postdraft demand for fish does not change.• Note that the demand curves before and

after the supply curve has shifted are identical.



After the draft, the quantity of fish supplied:• With fishermen being drafted and fewer

boats in the water, the supply of fish declines and the supply curve shifts to the left.



Postdraft, the equilibrium price of fish:

• The equilibrium price of fish increases from $4 to $10 after the draft.



After the draft, the quantity of fish bought and sold:• The quantity of fish bought and sold

declines from 10,000 to 7,000 fish.



The greater burden of the increased price for fish is felt by:• The poor

• The rich



The greater burden of the increased price for fish is felt by:• The increase in the price of fish makes it

unthinkable for the poor to purchase fish, while the rich hardly notice the increase and continue to buy fish.

Price CeilingPrice Ceiling


Price ceiling

• A maximum price set by government below the market-generated equilibrium price.

EXHIBIT 3 SETTING A $4 PRICE CEILING IN THE FISH MARKET


Exhibit 3: Setting a $4 Price Exhibit 3: Setting a $4 Price Ceiling in the Fish MarketCeiling in the Fish Market


In Exhibit 3, when a $4 price ceiling is set, the market for fish:• When the price ceiling is set at $4, the

quantity of fish demanded increases from 7,000 to 10,000.



In Exhibit 3, when a $4 price ceiling is set, the market for fish:• Based on the post-draft supply curve, the

quantity of fish supplied falls from 7,000 to 4,000.



In Exhibit 3, when a $4 price ceiling is set, the market for fish:• Based on the postdraft supply curve, there

is a shortage—an unsatisfied excess demand—of 6,000 fish.



Allocate a shortage of goods:

• One method is through the use of ration coupons.




• Ration coupons are issued by the government, entitling the holder to purchase a specific quantity of a good at or below the price ceiling.




Ration coupons may be issued based on schemes such as:• First come, first served

• Lottery

• Household size

Price Ceiling and HousingPrice Ceiling and Housing


Rent control is a government-set price ceiling on rent.

Price Ceiling and HousingPrice Ceiling and Housing


Arguments against rent control:

• It dampens landlords’ incentives to properly maintain their existing rental units.

• It discourages many people from investing in new construction.

Price FloorsPrice Floors


Price floor

• A minimum price set by government above the market-generated equilibrium price.

EXHIBIT 4 EFFECT OF NEW TECHNOLOGY ON THE FISH MARKET


Exhibit 4: Effect of New Exhibit 4: Effect of New Technology on the Fish MarketTechnology on the Fish Market


When a new technology is adopted, the supply curve in the fish market:

• The supply curve shifts the the right.



After adopting the new technology, total revenue for the fisherman:

• Total revenue decreases.



After adopting the new technology, total revenue for the fisherman: • Prior to adopting the new technology,

10,000 fish were sold at an equilibrium price of $4 each, for a total revenue of $40,000.



After adopting the new technology, total revenue for the fisherman: • After adopting the new technology, 12,000

fish are sold at an equilibrium price of $2 each, for a total revenue of $24,000.

EXHIBIT 5 SETTING A $4 PRICE FLOOR IN THE FISH MARKET


Exhibit 5: Setting a $4 Price Exhibit 5: Setting a $4 Price Floor in the Fish MarketFloor in the Fish Market


In Exhibit 5, when a $4 price floor is set, the market for fish:• The quantity of fish supplied increases from

12,000 to 15,000.• The quantity of fish demanded declines from

12,000 to 10,000. • A surplus, or excess supply, of 5,000 fish

is created.

Exhibit 5: Setting a $4 Price Exhibit 5: Setting a $4 Price Floor in the Fish MarketFloor in the Fish Market


The excess supply of fish can be dealt with:• The decision to support a price floor is a

societal matter.

• If the community represented by the government wants to support the fishermen through a price floor, then the government will buy the excess supply.

EXHIBIT 6 GROWTH OF U.S. AGRICULTURAL PRODUCTIVITY THROUGHOUT U.S. HISTORY

* Precise data are not available.

Source: James Zelner and R.M. Lamm, “Agriculture’s Vital Role for Us All,” Food—From Farm to Table, 1982 Yearbook of Agriculture, Department of Agriculture, Washington, D.C., p. 3.


Exhibit 6: Growth of U.S. Agricultural Exhibit 6: Growth of U.S. Agricultural Productivity Throughout U.S. HistoryProductivity Throughout U.S. History


Agricultural productivity has increased in the U.S. because:• Changes in the dominant energy source

technology used on farms.

Exhibit 6: Growth of U.S. Agricultural Exhibit 6: Growth of U.S. Agricultural Productivity Throughout U.S. HistoryProductivity Throughout U.S. History


Agricultural productivity has increased in the U.S. because:• Advances in modern chemistry to produce

fertilizers, insecticides, crop ripeners and food preservatives.

EXHIBIT 7 EFFECT OF NEW TECHNOLOGY IN FARMING


Exhibit 7: Effect of New Exhibit 7: Effect of New Technology in FarmingTechnology in Farming


As new energy source technologies and modern chemistry increase productivity and shift the supply curve to the right, price:

• Price declines with each shift of the supply curve to the right.

Parity PricingParity Pricing


Parity pricing

• Parity pricing describes one criteria used to determine the level at which a price floor should be set.



• It asks for equality between the prices that farmers have to pay for the goods they buy, and the prices they get for the goods they sell.

Parity pricing



• Parity pricing was adopted by the government in 1933 when Congress passed the Agricultural Adjustment Act.

Parity pricing

EXHIBIT 8SHOES AND CORN: SHIFTS IN DEMANDAND SUPPLY: 1914–2004


Exhibit 8: Shoes and Corn: Shifts in Exhibit 8: Shoes and Corn: Shifts in Demand and Supply: 1914-2004Demand and Supply: 1914-2004


In Exhibit 8, the market for shoes changes from 1914 to 2004:• While the supply curve for shoes remained

unchanged, the demand curve for shoes shifted to the right.



In Exhibit 8, the market for shoes changes from 1914 to 2004:• The shift in demand raised the equilibrium

price for shoes from $2 to $4.



The market for corn changed in the same time period:• The demand curve for corn remained

unchanged, while breakthroughs in technology and chemicals shifted the supply curve for corn to the right.



The market for corn changed in the same time period:• The equilibrium price of corn declined from

$2 in 1914 to $1 in 2004.



Parity pricing affects the quantity of corn demanded and supplied:• Parity pricing, setting a price floor of $4 for

corn, restores the exchange parity between corn and shoes.



Parity pricing affects the quantity of corn demanded and supplied:• It also creates an excess supply of 50

million bushels of corn.

Parity Price RatioParity Price Ratio


Parity price ratio

• The relationship between prices received by farmers and prices paid by farmers.

EXHIBIT 9 PARITY PRICE RATIOS OF PRICES RECEIVED AND PAID BY FARMERS: 1910–2000


Exhibit 9: Parity Price Ratios of Exhibit 9: Parity Price Ratios of Prices Received by Farmers and Paid Prices Received by Farmers and Paid

by Farmers: 1910–2000by Farmers: 1910–2000


Changes in the parity price ratio since 1910:• Except for the period between 1910 and 1920

and during the 1940s, the parity price ratio has been on the decline.

Freedom to Farm Act of 1996Freedom to Farm Act of 1996


Freedom to Farm Act of 1996

• Legislation enacted by Congress that phases in, over a 7-year transitional period, the complete dismantling of the government’s farm price support and crop restriction systems.

EXHIBIT 10 Farm Bill Legislation: 1933–2008


The Farm Bill of 2008The Farm Bill of 2008


Farm Bill of 2008• The Food, Conservation, and Energy Act of

2008 continues the 2002 Farm Act and likewise covers income and commodity price support, land conservation, water and farmland protection and development of rural renewable energy sources. The cost of the bill for its 5-year term is about $300 billion.

Farm Subsidies around Farm Subsidies around the Worldthe World


Source: Organization for Economic Cooperation and Development.

A Long Tradition of Price A Long Tradition of Price Ceilings and Price FloorsCeilings and Price Floors


Usury

• Originally, the charging of interest on loans, but it has come to mean the charging of unreasonably high rates of interest. Usury laws have been enacted to fix the maximum price of borrowing money since ancient times.

chapter 6 price ceilings and price floors gottheil principles of economics, 7e © 2013 cengage...

Documents

fish market

quantity of fish

fish doesnt

increased price

supply of fish declines

rich slide

maximum price set

defense goods