IUP ECON 122 - Chapter 5: Price Controls and Quotas: Meddling with Markets

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Chapter 5: Price Controls and Quotas: Meddling with MarketsWhy Governments Control Prices- price controls: are legal restrictions on how high or low a market price may go. They can take two forms: a price ceiling or a price floor- price ceiling: a maximum price sellers are allowed to charge for a good or service- price floor: a minimum price buyers are required to pay for a good or service- government legislates prices down by imposing a price ceiling- government legislates prices up by imposing a price floorPrice Ceilings- price ceilings are typically imposed during crises - wars, harvest failures, natural disasters - because these events often lead to sudden price increases that hurt many people but produce big gains for a lucky few- the U.S. government imposed ceilings on many prices during WWII: the war sharply increased demand for raw materials, such as aluminum and steel, and price controls prevented those with access to these raw materials from earning huge profitsModeling a Price Ceiling- look at 5-1 and 5-2 for examples- if a price ceiling is set above the equilibrium price it won't have any effect- binding: constrains market behavior- if a price ceiling is set below the equilibrium price it usually results in shortagesHow a Price Ceiling Causes InefficiencyInefficiently Low Quantity- deadweight loss: the loss in total surplus that occurs whenever an action or a policy reduces the quantity transacted below the efficient market equilibrium quantity- it's a loss to society, it is a reduction in total surplus, a loss in surplus to one person that then accrues as a gain to someone else, what an economist would call a transfer of surplus from one person to another- inefficient allocation to consumers, wasted resources, and inefficiency low quality lead to a loss of surplus over and above the deadweight lossInefficient Allocation to Consumers- efficient allocation of apartments would be that people who really want an apartment will get one and people who aren't all that anxious to get one wont - inefficient allocation of apartments people who aren't anxious to find an apartment will get one and others who are very anxious to find an apartment wont- price ceilings often lead to inefficiency in the form of inefficient allocation to consumers- inefficient allocation to consumers: some people who want the good badly and are willing to pay a high price don't get it, and some who care relatively little about the good and are only willing to pay a low price do get itWasted Resources- price ceilings typically lead to inefficiency in the form of wasted resources- wasted resources: people expend money, effort, and time to cope with the shortages caused by the price ceiling- rent control creates missed opportunitiesInefficiently Low Quality- inefficiently low quality: sellers offer low-quality goods at a low price even though buyers would prefer a higher quality at a higher price Black Markets- black market: a market in which goods or services are bought and sold illegally - either because it is illegal to sell them at all or because the prices charged are legally prohibited by a price ceilingWhy Are There Price Ceilings?- three most common results of price ceilings:1. a persistent shortage of the good2. inefficiency arising from this persistent shortage in the form of inefficiently low quantity (deadweight loss), inefficient allocation of the good to consumers, resources wasted in searching for the good, and the inefficiently low quality of the good offered for sale3. the emergence of illegal, black market activity- those who benefit from the controls are typically better organized and more vocal than those who are harmed by themPrice Floors- price floors have been widely legislated for agricultural products, such as wheat and milk, as a way to support the incomes of farmers- minimum wage: legal floor on the wage rate, which is the market price of labor- price floor does not always lead to an unwanted surplusHow a Price Floor Causes Inefficiency- the persistent surplus that results from a price floor creates missed opportunities - inefficiencies - that resemble those created by the shortage that results from a price ceiling- these include: deadweight loss from inefficiently low quantity, inefficient allocation of sales among sellers, wasted resources, inefficiently high quality, and the temptation to break the law by selling below the legal price Inefficiently Low Quantity- since a price floor raises the price of a good to consumers, it reduces the quantity of that good demanded; because sellers can't sell more units of a good than buyers are willing to buy, a price floor reduces the quantity of a good bought and sold below the market equilibrium quantity and leads to a deadweight loss- price ceiling also reduces the quantity of a good bought and sold- a price floor that reduces the quantity below the equilibrium quantity reduces total surplus- total surplus is the sum of the area above the supply curve and below the demand curveInefficient Allocation of Sales Among Sellers- price floors lead to inefficient allocation of sales among sellers- inefficient allocation of sales among sellers: those who would be willing to sell the good at thelowest price are not always those who actually manage to sell itWasted Resources- the surplus production gets destroyedInefficiency High Quality- buyers prefer high quality products and are willing to pay for them, but sellers refuse to improve the quality of their products because the price ceiling prevents their being compensated for doing so- inefficiently high quality: sellers offer high-quality goods at a high price, even though buyers would prefer a lower quality at a lower priceIllegal Activity- price floors provide incentives for illegal activitySo Why Are There Price Floors?- price floor creates various negative side effects:- a persistent surplus of the good- inefficiency arising from the persistent surplus in the forms of inefficiently low quantity (deadweight loss), inefficient allocation of sales among sellers, wasted resources, and aninefficiently high level of quality offered by suppliers- the temptation to engage in illegal activity, particularly bribery and corruption of government officials- price floors benefit some influential sellersControlling Quantities- quantity control (quota): an upper limit on the quantity of some good that can be bought or sold. - quota limit: the total amount of the good that can be legally


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IUP ECON 122 - Chapter 5: Price Controls and Quotas: Meddling with Markets

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