Applying Supply Demand Analysis The Case of Price Ceilings and Disaster Relief Ceiling Prices Floor Prices and Black Markets A CEILING PRICE is Ceiling Prices Floor Prices and Black Markets A CEILING PRICE is a maximum legal price at which a commodity can be traded Ceiling Prices Floor Prices and Black Markets A CEILING PRICE is a maximum legal price at which a commodity can be traded A FLOOR PRICE is a Ceiling Prices Floor Prices and Black Markets A CEILING PRICE is a maximum legal price at which a commodity can be traded A FLOOR PRICE is a minimum legal price at which a commodity can be traded Ceiling Prices Floor Prices and Black Markets Whenever a commodity is traded at a price above its ceiling price or at a price below its floor price the trade is illegal and is called Ceiling Prices Floor Prices and Black Markets Whenever a commodity is traded at a price above its ceiling price or at a price below its floor price the trade is illegal and is called black Ceiling Prices Floor Prices and Black Markets Whenever a commodity is traded at a price above its ceiling price or at a price below its floor price the trade is illegal and is called black Any price at which such an illegal trade is made is called a Ceiling Prices Floor Prices and Black Markets Whenever a commodity is traded at a price above its ceiling price or at a price below its floor price the trade is illegal and is called black Any price at which such an illegal trade is made is called a black market price Ceiling Prices Floor Prices and Black Markets A well known example of a federally mandated US floor price is Ceiling Prices Floor Prices and Black Markets A well known example of a federally mandated US floor price is the minimum wage rate Ceiling Prices Floor Prices and Black Markets A well known example of a federally mandated US floor price is the minimum wage rate A well known example of a locally mandated ceiling price is Ceiling Prices Floor Prices and Black Markets A well known example of a federally mandated US floor price is the minimum wage rate A well known example of a locally mandated ceiling price is rent control Ceiling Prices Floor Prices and Black Markets We shall examine in detail the use of ceiling prices to regulate markets for essential commodities immediately after Hurricane Hugo devastated parts of South Carolina Hurricane Hugo Price Ceilings and Disaster Relief All electrical power was knocked out in Charleston and nearby areas Water purifiers bottled water ice and propane were in high demand Tarpaulins were needed to cover holes in roofs Chainsaws were in heavy demand Hurricane Hugo Price Ceilings and Disaster Relief Portable generators were needed to provide electric power Stores were heavily damaged so many essential items were scarce Hurricane Hugo Price Ceilings and Disaster Relief The natural response of markets to greatly increased demand and severely reduced supply is Hurricane Hugo Price Ceilings and Disaster Relief The natural response of markets to greatly increased demand and severely reduced supply is that prices increase greatly Hurricane Hugo Price Ceilings and Disaster Relief The Mayor wished to ensure that people who wanted to buy essentials did not face high prices High prices might mean that people could not afford essential items Hurricane Hugo Price Ceilings and Disaster Relief The Mayor directed that the local markets for essentials be subject to ceiling prices set at the normal prices for those commodities Just a few days after the storm and well before any intervention by the FEMA private individuals in neighboring localities that escaped the storm were loading trucks with needed goods and preparing to sell these items in the devastated areas Hurricane Hugo Price Ceilings and Disaster Relief Just a few days after the storm and well before any intervention by the FEMA private individuals in neighboring localities that escaped the storm were loading trucks with needed goods and preparing to sell these items in the devastated areas The Mayor let it be known that these individuals would also be subject to the price ceilings few came Hurricane Hugo Price Ceilings and Disaster Relief Were the Mayor s actions rational Hurricane Hugo Price Ceilings and Disaster Relief Were the Mayor s actions rational Rational with respect to what goals Hurricane Hugo Price Ceilings and Disaster Relief The goals of a relief effort should include i Increase the available quantities of essentials Hurricane Hugo Price Ceilings and Disaster Relief The goals of a relief effort should include i Increase the available quantities of essentials ii Ensure that the available essentials are efficiently used in the sense that they are consumed by the people who most value them Hurricane Hugo Price Ceilings and Disaster Relief The goals of a relief effort should include i Increase the available quantities of essentials ii Ensure that the available essentials are efficiently used in the sense that they are consumed by the people who most value them iii Ensure that life support is available to all who need it Before Hugo The normal before the storm operation of the market for an essential is shown in the following picture Notice that P1 is the normal price for the essential Before Hugo Price S1 D1 P1 Q1 QD QS After Hugo with no price ceiling Hugo caused a big increase in the market demand for the essential and a big decrease in the market supply of the essential These changes cause the free market clearing price for the essential to After Hugo with no price ceiling Price D2 S2 P2 S1 D1 P1 Q2 Q1 QD QS After Hugo with no price ceiling Hugo caused a big increase in the market demand for the essential and also a big decrease in the market supply of the essential These changes cause the free market clearing price for the essential to rise sharply from P1 to P2 the price gouging effect After Hugo with no price ceiling These changes cause the free market clearing price for the essential to rise sharply from P1 to P2 the price gouging effect Even so the free market continues to match After Hugo with no price ceiling These changes cause the free market clearing price for the essential to rise sharply from P1 to P2 the price gouging effect Even so the free market continues to match the buyers most willing to pay with the buyers most willing to sell After Hugo with no price ceiling What is the effect on quantity supplied of a very high marketclearing price for the essential After Hugo with no price ceiling Price D2