INTERFERENCE IN MARKETS HAS CONSEQUENCES Distorted price signals cause resources to be misallocated. TO TO WEST Price Controls and Quotas NORTH TO 31 31 601 219 NORTH ING To 281 TO 985 SOUTH NOISE IN ON ERSI T JE 28 GENCY HE SEL If prices are distorted, they cannot give good information to buyers and sellers. 1 What you will learn in this chapter PRICE CONTROLS Price controls: legal restrictions on how high The meaning of price controls and quantity controls, or low a market price may go. There are two kinds of government intervention in markets two main types: How price and quantity controls create problems and Price ceiling: a maximum price sellers are can make a market inefficient What deadweight loss is allowed to charge for a good or service Why the predictable side effects of intervention in (usually set BELOW equilibrium). markets offen lead economists to be skeptical of its Price floor: a minimum price buyers are usefulness required to pay for a good or service Who benefits and who loses from market interventions, (usually set ABOVE equilibrium). and why they are used despite their well-known problems To First 2 5 INTERFERENCE IN MARKETS HAS PR ICE CEILINGS, CONSEQUENCES Venezuela's food shortages: Price ceilings may be well intentioned but are usually not a good idea. New York City's laws create shortages of licensed taxicabs and housing: a good idea? 3HOW PRICE CEILINGS CAUSE BINDING, OR EFFECTIVE, PRICE INEFFICIENCY CEILINGS Monthly rent If a price ceiling is set above equilibrium, it will have no effect Price ceilings cause predictable side apartment ) (called nonbinding). effects: $1,400 Nonbinding Inefficiently low quantity price ceiling 1.200 Only a price ceiling Inefficient allocation to customers that forces price 1,000 below equilibrium Wasted resources will have any effect Inefficiently low quality Binding, or effective. (called binding or price ceiling 600 effective). Black markets 2.0 22 Quantity of apartments (milions ) 10 THE MARKET FOR APARTMENTS LEARN BY DOING: PRACTICE QUESTION Monthly rent Homeowners near Middletown University's stadium used to rent parking spaces in their driveways to apartment) Quantity of apartments Monthly rent millions fans at a going rate of $11. $1,400 apartment) Quantity Quantity demanded A new town ordinance now sets a maximum 1.6 parking fee of $7. Use the accompanying supply 1,300 1,200 2.2 and demand diagram to answer the following 2.1 questions. 1,000 Parking fee 900 700 609 1.6 1.7 1.8 1.9 20 2.1 2.2 23 2.4 Quantity of apartments [ millions) steve learning Quantity of parking spaces 11 THE EFFECTS OF A PRICE CEILING LEARN BY DOING: PRACTICE QUESTION Monthly rent Given the new price of $7, some homeowners now apartment) $1,400 think it's not worth the hassle to rent out spaces. This causes: 1,200 a) supply to shift left. b) quantity to decrease along the supply curve. 1,000 Price ceiling Parking fee Arn sing shortage of 400,000 00 apartments caused by price X 1.8 20 24 Quantity of apartments (milions) 9 12INEFFICIENT ALLOCATION TO LEARN BY DOING: PRACTICE QUESTION CUSTOMERS Some fans who used to carpool drive to the game Price controls distort signals that would help the alone because of the lower price of parking. This causes: goods get allocated their highest-valued uses a) demand to shift right. Consumers who value a good most don't necessarily quantity demanded to increase along the get it. demand curve. So producers have no incentive to supply the good to Parking fee the "right" people first As a result, goods are misallocated. Universal price Just another day in a controls caused USSR bread line. widespread and Average time in line persistent for a Soviet woman? Quantity of parking spaces shortages in the 2 hours every day. live Learning USSR. days a week. 13 16 INEFFICIENTLY LOW QUANTITY WASTED RESOURCES Price controls that create shortages lead to bribery and wasteful lines. Shortages: not all buyers will be able to purchase the good. GREEN FLAG WELCOME Normally, buyers would compete When prices are held below the market YELLOW FLAG with each other by offering a higher price, shortages are created. .TRUCK'S BURDEN. CHECK price The lower the controlled price relative to NO LOSED GAS If price is not allowed to rise, buyers the market equilibrium price, the larger the must compete in other ways (waiting shortage. in line, illegal bribes and favors) 14 17 LEARN BY DOING: PRACTICE QUESTION NEFFICIENTLY LOW QUALITY If the government imposed a maximum parking fee At the controlled price, sellers have of $7, you would expect there to be a(n) more customers than goods. of parking spaces. a) shortage In a free market, this would be an opportunity o) surplus to profit by raising prices. c) equilibrium number of But when prices are controlled, sellers cannot. Parking fee Sellers respond to this problem in two ways: $15 Reduce quality Reduce service When did full-service gas stations go away? During the Quantity of parking spaces price ceilings in the 1970s. 15 18PRICE FLOORS HOW A PRICE FLOOR CAUSES Sometimes governments intervene to push INEFFICIENCY market prices up instead of down. Price floors cause predictable side effects: The generous Deadweight loss from inefficiently low OFICINA DE EMPLEO minimum wage in quantity many European Inefficient allocation of sales among countries has sellers contributed to a high Wasted resources rate of unemployment and the flourishing of Inefficiently high quality an illegal labor Temptation to break the law by selling market. below the legal price 25 28 THE MARKET FOR BUTTER IN THE ABSENCE THE EFFECTS OF A PRICE FLOOR OF GOVERNMENT CONTROLS Price of butter Price of (per pound] butter [per pound) $1.40 Butter surplus of 3 million pounds caused by price floor $1.40 Quantity of butter 1.20 1.30 (millions of pounds) 1.20 Price of butter Quantity Quantity (per pound) demanded supplied E 1.00 floor 1.10 8.0 14.0 1.30 1.00 1.30 13.0 1.20 120 0.90 1.10 9 5 11.0 0.80 0.80 1,00 10.0 10.0 0.90 10.5 9.0 0.70 0.80 11.0 0.60 8.0 0.60 0.70 11.5 7.0 0.60 12.0 6.0 12 ILL 10 11 12 13 14 Quantity of butter [millions of pounds] Quantity of butter ( milions of pounds) 26 29 BINDING, OR EFFECTIVE, PRICE NEFFICIENT ALLOC/ FLOORS AMONG SELLERS butter If a price floor is set below equilibrium, it Price floors misallocate sales by: per pound) will have no effect (called nonbinding). $1.40 Allowing high-cost firms to operate. Binding, or effective. price floor Preventing low-cost firms from entering the industry. 1.20 Price floors and regulation prevented Southwest Only a price floor (and 79 other firms) from entering the national 1.00 that forces price market above equilibrium 0.80 will have any Good jo000000000008060906 Nonbinding price floor effect (binding, or 0.60 effective). Quantity of butter (milions of pounds) 27 30WASTED RESOURCES SO WHY ARE THERE PRICE FLOORS? Price floors encourage waste. Same as price ceilings: To deal with the surplus generated by They do benefit some people (who are typically better organized and more vocal than those who agricultural price floors, the U.S. are harmed by them). government sometimes buys back the excess and donates or destroys it. If the price floor is longstanding, buyers may not have a realistic idea of what would happen without it. Government officials often do not understand supply and demand analysis. 31 34 NEFFICIENTLY HIGH QUALITY Higher quality raises costs and reduces sellers' ECONOMICS IN ACTION profit. THE RISE AND FALL OF THE Buyers get higher quality but would prefer a lower UNPAID INTERN price. What keeps firms from abusing Price floors encourage sellers to waste resources: this practice? higher quality than buyers are willing to pay for 2010 new Dep't of Labor rules: unpaid internships must be Primarily for the benefit of the a.bacell intern and not the employer "We have an opening for a part- . Comparable to training offered time unpaid intern, which could lead to a full-time unpaid by an educational environment internship." No displacement of a regular employee by the intern Most flyers prefer a lower ticket price (with no food included)s 32 35 ILLEGAL ACTIVITY PITFALLS Price floors encourage black markets. Don't be confused: price ceilings , floors and There are willing sellers (and buyers) at quotas all decrease the amount traded and illegal prices, so they are tempted to break therefore create deadweight loss. the law and trade with each other. A price ceiling pushes the price of a good down; fewer Australi A$15.74 - sellers will want to sell France E9.31 - US$11.70 A price floor pushes the price of a good up; fewer In Spain it's estimated buyers will want to buy. Treland E8.65 - US$10.90 that 1/3 of the Canada ($11.00* - US$30.79 "unemployed" have A quota, by definition, reduces sales. Britain E6.11 - US$9.40 under-the-table jobs. If sellers don't want to sell as much as buyers want United States $7.25 to buy, it's the sellers who determine the actual 0 2 4 6 8 10 12 14 $16 quantity sold, because buyers can't force Minimum wage (per hour) BURGE! ORGANIZATION FOR ECONOMIC COOPERATION AND DEVELOPMENT unwilling sellers to sell and vice versa. 33 36CONTROLLING QUANTITIES EFFECT OF A QUOTA ON THE Governments sometimes control quantity MARKET FOR TAXI RIDES instead of price. Quantity of rides ( per ride) [millions per year) Quota: an upper limit, set by the government, Fare Quantity Quantity per ride) demanded supplied on the quantity of some good that can be $7.00 $7.00 6.50 14 bought or sold; also referred to as a quantity 6.50 6.00 6.00 control. 5.50 5 50 11 5.00 5.00 10 10 Quota limit: the total amount of a good under a 4.50 - 4.50 11 quota or quantity control that can be legally 4.00 4.00 3.50 3.50 transacted 3.00 3 00 Quota License: the right, conferred by the government, to supply a good. Quantity of rides (milions per year) 37 40 THE MARKET FOR TAXI RIDES IN THE THE COSTS OF QUANTITY CONTROLS ABSENCE OF GOVERNMENT CONTROLS Like price controls, quotas impose losses on society. Fare Quantity of rides Deadweight loss (some mutually beneficial transactions (per ride (millions per year) Fare don't occur) Quantity Quantity per ride) demanded supplied Incentives for illegal activities $7.00 $7.0 6 6.50 6.50 7 13 6.00 6.00 12 540 00 11 5.50 5.50 5.00 . 5.00 10 10 4.50 9 4.50 11 4.00 4.00 3.50 13 3.50 3.00 3.00 Unlicensed cabs are a side effect of quantity controls... but also an opportunity for alternate models like Uber. 8 9 10 11 12 13 14 Quantity of rides [ millions per year) 38 41 EARN BY DOING: DISCUSS LEARN BY DOING: PRACTICE QUESTION With a partner, choose either to Economics in the news - How many concepts can 1. defend the United States' you identify from these stories? sugar import quotas or https://www.marketplace.org/2020/07/02/what-will-happen-to-new- yorks-sky-high-rents/ 2. attack them. https://www.marketplace.org/2020/05/06/land-olakes-ceo-on-why-some- Imagine you are a young farmers-are-dumping-milk/ congressional staffer charged https://www.marketplace.org/2020/08/06/want-to-understand-the-laws- with collecting arguments to of-supply-and-demand-watch-the-dairy-Industry/ use for your side in Congress. https://www.marketplace.org/2020/08/21/low-rates-and-heavy-buyer- Brainstorm two or more demand-send-home-sales-surging/ arguments you would use and http://broadwayeconomics.com/blankets-bedding/ be ready to share. ellys Learning