Price Controls:

Ceilings and Floors

Government Intervention

Should the government place a price ceiling (maximum price) to make housing more

affordable?

The Market for Apartments

P

QD

SRental price

of apts

$2800

300

Quantity of apartments

$3500

$2500

What price should the price ceiling be set at?

How Price Ceilings Affect Market Outcomes

A price ceiling above the equilibrium price is not binding –it has no effect on the market outcome.

P

QD

S

$2800

300

Price ceiling

$3500

How Price Ceilings Affect Market Outcomes

The price ceiling

must below the market price to be effective.

A PC of $2500

would actually make housing more affordable.

P

QD

S

$2800

Price ceiling

$2500

250 400

How Price Ceilings Affect Market Outcomes

What is the

unintended consequence of this price ceiling?

What happens to

the quality of apartments that remain on the

market?

P

QD

S

$2800

Price ceiling

$2500

250 400

shortage

$2800

300

Price Ceiling

� Government imposes a maximum

price less than Pe.

� Generally on essential items that

have a very high market equilibrium price.

� ex. housing � rent control

� This generates a shortage (Qd > Qs).

� The market mechanism cannot clear

the market.

� A permanent shortage exists. D

SP

Q

Pe

Qe

Price

ceiling

Qs Qd

Shortage

Shortages and Rationing

� With a shortage, sellers must ration the goods among

buyers.

� Some rationing mechanisms: (1) long lines (2) discrimination according to sellers’ biases

� These mechanisms are often unfair, and inefficient: the goods don’t necessarily go to the buyers who value them most highly.

� In contrast, when prices are not controlled, the rationing mechanism is efficient (the goods go to the

buyers that value them most highly) and impersonal (and thus fair).

How Price Ceilings Affect Market Outcomes

How many

apartments would have been rented if there was no price

ceiling?

How many apartments are rented with this price

ceiling?

P

QD

S

$2800

Price ceiling

$2500

250 400

300

250 – only 250 can be rented if only 250 are supplied

$2800

300

How Price Ceilings Affect Market Outcomes

This price ceiling caused a loss of trades.

P

QD

S

$2800

Price ceiling

$2500

250 400

$2800

300

MISSED OPPORTUNITIES!!!

Price Floor

� Government imposes a minimum

price greater than Pe.

� Generally on essential items that

have a very low market equilibrium price

� ex. agricultural price supports,

minimum wage

� This generates a surplus (Qs > Qd).

� The market mechanism cannot clear the market.

� A permanent surplus exists.

D

SP

Q

Pe

Qe

Price

floor

Qd Qs

Surplus

Minimum Wage

Should the

government raise the federal

minimum wage to

$10?

How Price Floors Affect Market Outcomes

The floor is a binding constrainton the wage, and causes a surplus of labor (unemployment).

W

LD

S

$4

Price floor

$5

400 550

labor surplus

$4

500

The Minimum Wage

W

LD

S

$4

Min. wage

$5

400 550

unemployment

Min wage laws

do not affect

highly skilled workers.

They do affect

teen workers.

WHY?

Studies:

A 10% increase

in the min wage raises teen

unemployment by 1-3%.

What are the effects of price controls?

� Persistent shortages/surpluses

� A loss of gains from trades (DWL)

� Reduction in quality or inefficiently high quality

� Misallocation of resources� The person that needs the good may not end up getting it.

� Wasted time, effort and resources

� Emergence of black markets

WHY?

Price controls take away incentives that would otherwise regulate markets.

� Prices efficiently allocate resources. Resources

will only be used for only the most valuable purposes.

� Prices as Signals and Incentives

� Prices tell consumers and suppliers how to adjust. High prices are an incentive to suppliers to supply more. Low prices tell producers that a good is being over produced.

� Low prices to consumers signal to buy more of a good. A

high price is a sign to stop and think carefully before buying.