Supply Demand and Government Policies In a free unregulated market system market forces establish equilibrium prices and exchange quantities efficient While equilibrium conditions may be it may be true that not everyone is satisfied CONTROLS ON PRICES Are usually enacted when policymakers believe unfair the market price is to buyers or sellers Result in government created price ceilings and floors CONTROLS ON PRICES Price ceiling maximum A legal on the price at which a good can be sold Price floor minimum A legal on the price at which a good can be sold 1 A Market with a Price Ceiling not binding a A Price Ceiling That Is Price of Ice Cream Cone Supply 4 Price ceiling 3 Equilibrium price Demand Quantity of Ice Cream Cones 100 0 Equilibrium quantity A Market with a Price Ceiling Binding b A Price Ceiling That Is Price of Ice Cream Cone Supply Equilibrium price 3 2 Price ceiling Shortage Demand 0 75 125 Quantity supplied Quantity demanded Quantity of Ice Cream Cones How Price Ceilings Affect Market Outcomes Effects of Price Ceilings A binding price ceiling creates shortages because QD QS Example Gasoline shortage of the 1970s Nonprice rationing Examples Long lines discrimination by sellers 2 CASE STUDY Lines at the Gas Pump In 1973 OPEC raised the price of crude oil in world markets Crude oil is the major input in gasoline so the higher oil prices reduced the supply of gasoline What was responsible for the long gas lines Economists blame government regulations that limited the price oil companies could charge for gasoline The Market for Gasoline with a Price Ceiling Not binding a The Price Ceiling on Gasoline Is Price of Gasoline Supply S1 1 Initially the price ceiling is not binding Price ceiling P1 Demand 0 Quantity of Gasoline Q1 The Market for Gasoline with a Price Ceiling Binding b The Price Ceiling on Gasoline Is Price of Gasoline S2 2 but when supply falls S1 P2 Price ceiling 3 the price ceiling becomes binding P1 4 resulting in a shortage Demand 0 QS QD Q1 Quantity of Gasoline 3 CASE STUDY Rent Control in the Short Run and Long Run Rent controls are placed on the celings rents that landlords may charge their tenants The goal of rent control policy is to help the poor by making housing more affordable One economist called rent control the best way to destroy a city other than bombing Rent Control in the Short Run and in the Long Run a Rent Control in the Short Run supply and demand are inelastic Rental Price of Apartment Supply Controlled rent Shortage Demand Quantity of Apartments 0 Rent Control in the Short Run and in the Long Run b Rent Control in the Long Run elastic supply and demand are Rental Price of Apartment Supply Controlled rent Shortage 0 Demand Quantity of Apartments 4 How Price Floors Affect Market Outcomes When the government imposes a price floor two outcomes are possible below The price floor is not binding if set the equilibrium price above The price floor is binding if set the equilibrium price leading to a surplus A Market with a Price Floor not binding a A Price Floor That Is Price of Ice Cream Cone Supply Equilibrium price 3 Price floor 2 Demand 100 0 Equilibrium quantity Quantity of Ice Cream Cones A Market with a Price Floor binding b A Price Floor That Is Price of Ice Cream Cone Supply Surplus 4 3 Price floor Equilibrium price Demand 0 80 120 Quantity of Quantity Quantity Ice Cream Cones demanded supplied 5 How Price Floors Affect Market Outcomes price floor A prevents supply and demand from moving toward the equilibrium price and quantity When the market price hits the floor it can fall no further and the market price equals the floor price How Price Floors Affect Market Outcomes A binding price floor causes surplus a because QS QD nonprice rationing is an alternative mechanism for rationing the good using discrimination criteria Examples The minimum wage agricultural price supports The Minimum Wage An important example of a price floor is the minimum wage Minimum wage laws dictate the lowest price possible for labor that any employer may pay 6 How the Minimum Wage Affects the Labor Market Wage Labor Supply Equilibrium wage Labor demand 0 Equilibrium employment Quantity of Labor How the Minimum Wage Affects the Labor Market Wage Labor surplus unemployment Labor Supply Minimum wage Labor demand 0 Quantity demanded Quantity supplied Quantity of Labor 7