Chapter 5 Price Controls and Quotas Meddling with Markets Why 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 floor Price 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 profits Modeling 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 shortages How a Price Ceiling Causes Inefficiency would Inefficiently 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 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 loss Inefficient 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 and are only willing to pay a low price do get it the good Wasted 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 opportunities Inefficiently 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 ceiling Why Are There Price Ceilings three most common results of price ceilings 1 a persistent shortage of the good 2 inefficiency arising from this persistent shortage in the form of inefficiently low quantity deadweight loss inefficient allocation of the good to consumers resources good offered wasted in searching for the good and the inefficiently low quality of the for sale 3 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 them Price 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 surplus How 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 quantity and floor reduces the quantity of a good bought and sold below the market equilibrium 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 curve Inefficient 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 the lowest price are not always those who actually manage to sell it Wasted Resources the surplus production gets destroyed Inefficiency 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 price Illegal Activity price floors provide incentives for illegal activity So 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 an inefficiently 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 sellers Controlling 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 transacted license gives its owner the right to supply a good The Anatomy of Quantity Controls demand price of a given