Lecture Outline – Price Controls1. Analyzing the Impact of a Price Ceilinga. There is will a shortage, sellers wont provide as many textbooks for the given price.b. fewer are provided at a lower price. There will be a Dead Weight Loss. There are buyers willing to pay enough to cover the supply cost but price ceiling ruins the incentivec. Allocation of the resource will be left to some other mechanism other than price. Ex. waiting in line, demographics, etc...d. Quality of the product will be worse. No incentive· What is a price ceiling?o Legal maximum price that can be charged· What is the difference between a “binding price ceiling” and a “non-binding price ceiling?”o Constraint that can’t be ignored = bindingo If price ceiling is set above equilibrium, price ceiling is non-binding.1o Explain why a non-binding price ceiling will not affect the market equilib-rium.  There is no pressure on the marketo Use the supply and demand model to show the effect that a binding price ceil-ing has on the market price and quantity.o How is it determined who gets a good/service in the presence of a binding price ceiling? people waiting in line, etc... The buyer with the highest willingness to buy will not definitely get the good.o Does a binding price ceiling guarantee that the lowest cost producers sell the good? Does it guarantee that the buyers who value the good most consume the good? No because many people are willing to buy the good at that price so the person willing to pay more is in the same boat as the person willingto pay at the price ceiling. Same situation with producers.· Explain why a binding price ceiling:o Reduces product quality Supplier has no incentive to create good quality because they are get-ting a lower price.o Creates wasteful lines and other search costs Allocation of the resource will be left to some other mechanism other than price. Ex. waiting in line, demographics, etc...o Leads to unrealized gains from trade, i.e. deadweight loss There are buyers willing to pay enough to cover the supply cost but price ceiling ruins the incentive22. Analyzing the impact of a Price Floor· What is a price floor?o Legal minimum price that can be charged in the marketo Producers want to impose a price flooro Quantity supplied increases and quantity demanded decreases = surpluso Waste of resourceso Dead Weight Loss: Unrealized gains from trade is the surplus not being used· What is the difference between a “binding price floor” and a “non-binding price floor?”o Non-binding price floor is below the equilibrium price. There is a shortage. Nothing prohibits the price to rise, the good will continue to sell at the equilib-rium price.o Explain why a non-binding price floor will not affect the market equilibrium.  The price will rise back to equilibrium because suppliers are not will-ing to sell at anything lower than equilibriumo Use the supply and demand model to show the effect that a binding price floorhas on the market price and quantity.3oo Does a binding price floor guarantee that the lowest cost producers sell the good? Does it guarantee that the buyers who value the good most consume the good? No guarantee lowest producers because at a price floor, there are all the other suppliers who are willing and able to sell and since there is a minimum amount to sell for, the lowest producer has no advantage. There is no advantage· Explain why a binding price floor:o Leads to wasteful production Price flow creates a surplus and the surplus is wasted resources. Peoplewont buy a good that is above their willingness to pay. suppliers pro-duce more than consumers wanto Leads to unrealized gains from trade, i.e. deadweight loss Surplus is lost due to unrealized gains from trade.o Wasteful increases in product quality They can’t compete on a low price because everyone has the same price so they have to waste resources on quality that people really don’t want.4· Consider the example of the airline industry. Explain why in the presence of regual-tions airlines competed on quality and not price. Why is this type of competition not as desirable as it sounds? Hint: Which of the following would you prefer?o They couldn’t compete on price because of the price floor so they competed on quality- they used their surplus to pay for better quality (larger seats etc...) This was a quality waste, people just want to get there safe and cheap.o Pay $350 for a flight from RDU to NYC and get free meals, drinks, and no baggage fees? Oro Pay $200 for a flight from RDU to NYC where no meals or drinks are served and there is a limit on the amount of baggage you can carry onto the plane? This gets rid of the quality waste.3. Welfare Effects of Price Controls· Use a supply and demand graph to show the change in CS, PS, and TS when a bind-ing price ceiling is imposed. Assume that the consumers who value the good most 5buy the good.· Use a supply and demand graph to show the change in CS, PS, and TS when a bind-ing price floor is imposed. Assume that the producers who have the lowest marginal production costs sell the good.· In each case, identify the DWL on your graph.· What is a “black market?” When are black markets likely to emerge?6o Black markets can emerge - secondary market where product is exchanged in an informal marketo So many people want the product but only so many people can get the good soblack markets emerge because there are so many desperate buyers.o Price would be as high as whatever consumers are willing to pay for the good.At minimum wage. the quantity demanded of labor falls below the market employment level (equilibrium) and the quantity supplied rises, creating a surplus of labor. Therefore, minimum wage creates unemployment due to a labor