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Price Controls
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legal restrictions on how high or low a market price may go
occurs when a government intervenes to regulate prices
two forms: price ceilings and price floors
ceiling pushes price of good down
floor pushes price of good up
both reduce the quantity bought and sold
Example: government puts a limit on the price landlords can charge for apartments if the equilibrium price leads to rental rates that an average working person can't afford
occurs when a government intervenes to regulate prices
two forms: price ceilings and price floors
ceiling pushes price of good down
floor pushes price of good up
both reduce the quantity bought and sold
Example: government puts a limit on the price landlords can charge for apartments if the equilibrium price leads to rental rates that an average working person can't afford
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Price Ceiling
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a form of price control that sets a maximum price that sellers are allowed to charge for a good
causes shortages if it if placed below the equilibrium price (greater quantity demanded than quantity supplied)
government intervenes to push market prices down
Example: rent control in New York (government places a limit on what landlords can charge)
cause inefficient allocation to consumers, wasted resources, inefficiently low quality, and black markets
occur because they do benefit some buyers, and buyers may not have a realistic idea of what would happen without them, and government officials to not understand supply and demand analysis
imposed during crises (wars, harvest failures, natural disasters)
causes shortages if it if placed below the equilibrium price (greater quantity demanded than quantity supplied)
government intervenes to push market prices down
Example: rent control in New York (government places a limit on what landlords can charge)
cause inefficient allocation to consumers, wasted resources, inefficiently low quality, and black markets
occur because they do benefit some buyers, and buyers may not have a realistic idea of what would happen without them, and government officials to not understand supply and demand analysis
imposed during crises (wars, harvest failures, natural disasters)
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Price Floor
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a form of price control that sets a minimum price that buyers are required to pay for a good
governments intervene to push market prices up
Examples: minimum wage and agricultural products (wheat and milk, support incomes of farmers)
causes a surplus as long as floor is above equilibrium price (quantity supplied is greater than quantity demanded)
leads to inefficient allocation of sales among sellers, wasted resources, inefficiently high quality, and illegal activity (black labor)
occur because government officials do not understand supply and demand analysis and because they benefit some influential sellers
governments intervene to push market prices up
Examples: minimum wage and agricultural products (wheat and milk, support incomes of farmers)
causes a surplus as long as floor is above equilibrium price (quantity supplied is greater than quantity demanded)
leads to inefficient allocation of sales among sellers, wasted resources, inefficiently high quality, and illegal activity (black labor)
occur because government officials do not understand supply and demand analysis and because they benefit some influential sellers
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Non-binding
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when a price control doesn't actually constrain market behavior
Example: if the price ceiling on apartment prices was placed above the equilibrium price
Example: if the price ceiling on apartment prices was placed above the equilibrium price
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Efficiency
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when there is no way to make some people better off without making others worse off
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Inefficient
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when there are missed opportunities in a market or an economy; some people could be made better off without making other people worse off
Example: rent control leads to this phenomenon in the form of allocation of apartments to renters, time wasted searching for apartments, and low quality or condition in which landlords maintain apartments
Example: rent control leads to this phenomenon in the form of allocation of apartments to renters, time wasted searching for apartments, and low quality or condition in which landlords maintain apartments
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Competitive Market
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markets with many buyers and sellers in which no buyer or seller can have any influence on the price
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Inefficient Allocations to Consumers
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a form of inefficiency caused by price ceilings, in which people who want the good badly and are willing to pay a high price don't get it, and those who care relatively little about the good and are only willing to pay a low pride to get it
Example: rent control in NYC - some people who are not especially anxious to find an apartment will get one but others who are very anxious to find an apartment, and might even be willing to pay more for it, won't
Example: rent control in NYC - some people who are not especially anxious to find an apartment will get one but others who are very anxious to find an apartment, and might even be willing to pay more for it, won't
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Wasted Resources
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a form of inefficiency caused by price ceilings, in which people spend money and expended effort in order to deal with the shortages caused by the price ceiling
Example: a family in NYC would waste their time and forgo leisure or income to look for an apartment that would be difficult to find due to the shortage created by a price ceiling
also a form of inefficiency caused by price floors
Examples: surplus generated of agricultural products must either be destroyed or stored by the government, would be workers searching for a job waste their time looking for one (won't be hired because of minimum wage that some company owners can't afford)
Example: a family in NYC would waste their time and forgo leisure or income to look for an apartment that would be difficult to find due to the shortage created by a price ceiling
also a form of inefficiency caused by price floors
Examples: surplus generated of agricultural products must either be destroyed or stored by the government, would be workers searching for a job waste their time looking for one (won't be hired because of minimum wage that some company owners can't afford)
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Inefficiently Low Quality
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a form of inefficiency caused by price ceilings, in which sellers offer low quality goods at a low price even though buyers would prefer a higher quality at a higher price
Example: with a price ceiling on rent control, landlords have no incentive to provide better conditions because they cannot raise rents to cover their repair costs but are still able to find tenants easily
Example: with a price ceiling on rent control, landlords have no incentive to provide better conditions because they cannot raise rents to cover their repair costs but are still able to find tenants easily
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Black Market
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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
encourages disrespect for the law and worsens the position of those who are trying to be honest
Example: with rent control and the shortage it causes, a landlord may give the apartment to a customer who is willing to slip him/her a few extra hundred dollars a month
encourages disrespect for the law and worsens the position of those who are trying to be honest
Example: with rent control and the shortage it causes, a landlord may give the apartment to a customer who is willing to slip him/her a few extra hundred dollars a month
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Minimum Wage
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a legal floor on the wage rate, which is the market price of labor
an example of a price floor in the United States and many other countries
an example of a price floor in the United States and many other countries
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Inefficient Allocation of Sales Among Sellers
answer
those who would be willing to sell the good at the lowest price are not always those who actually manage to sell it
Example: Belgium has a high minimum wage, Rosetta loses her job at a fast food restaurant because the owner replaces her with his son and can't afford both workers, Rosetta would be willing to work for less money, which would generate more money for the owner (inputs = less expensive), but it is illegal to hire Rosetta for less than the minimum wage
Example: Belgium has a high minimum wage, Rosetta loses her job at a fast food restaurant because the owner replaces her with his son and can't afford both workers, Rosetta would be willing to work for less money, which would generate more money for the owner (inputs = less expensive), but it is illegal to hire Rosetta for less than the minimum wage
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Inefficiently High Quality
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a form of inefficiency caused by a price floor, in which sellers offer high quality goods at a high price, even though buyers would prefer a lower quality at a lower price
Example: airfare used to be much higher, as they were not allowed to compete for customers by offering lower ticket prices (price ceiling) so they offered expensive, lavish services that increased the price
Example: people with college degree working at a super market as a cashier
Example: airfare used to be much higher, as they were not allowed to compete for customers by offering lower ticket prices (price ceiling) so they offered expensive, lavish services that increased the price
Example: people with college degree working at a super market as a cashier
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Black Labor
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an illegal activity caused by price floors in which workers desperate for jobs sometimes agree to work off the books and under the minimum wage
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Quota
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an upper limit on the quantity of some good that can be bought or sold placed by the government
limit on the quantity rather than the price at which it is transacted
Example: taxi medallion system limits the number of taxis that can be used
quantity control
always set an upper, not a lower, limit on quantities (no one can be forced to buy or sell more than they want to)
causes inefficiency due to missed opportunities (deadweight loss - mutually beneficial transactions are not occurring)
as log as the demand price of a given quantity exceeds the supply price, there is a missed opportunity
because there are transactions people would like to make but cannot, these limits generate illegal activity
limit on the quantity rather than the price at which it is transacted
Example: taxi medallion system limits the number of taxis that can be used
quantity control
always set an upper, not a lower, limit on quantities (no one can be forced to buy or sell more than they want to)
causes inefficiency due to missed opportunities (deadweight loss - mutually beneficial transactions are not occurring)
as log as the demand price of a given quantity exceeds the supply price, there is a missed opportunity
because there are transactions people would like to make but cannot, these limits generate illegal activity
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Quota Limit
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the total amount of the good that can be legally transacted
Example: in the taxi medallion system, it is the number of medallions given out
Example: in the taxi medallion system, it is the number of medallions given out
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License
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gives its owner the right to supply a good
Example: the medallion in the taxi medallion situation
Example: the medallion in the taxi medallion situation
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Demand Price
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the price at which consumers will demand that quantity
Example: At what price will consumers want to buy 10 million rides per year? the ________ price of 10 million rides is $5 per ride
Example: At what price will consumers want to buy 10 million rides per year? the ________ price of 10 million rides is $5 per ride
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Supply Price
answer
the price at which producers will supply that quantity
Example: At what price will suppliers be willing to supply 10 million rides per year? the _________ price of 10 million rides per year is $5 per ride
Example: At what price will suppliers be willing to supply 10 million rides per year? the _________ price of 10 million rides per year is $5 per ride
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Wedge
answer
a difference created between the demand price and the supply price of a good driven by a quantity control, or quota
the price paid by buyers ends up being higher than the received by sellers
Example: a quota of 8 million rides creates a supply price of $4 and a demand price of $6 (clear difference between the two prices)
the price paid by buyers ends up being higher than the received by sellers
Example: a quota of 8 million rides creates a supply price of $4 and a demand price of $6 (clear difference between the two prices)
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Quota Rent
answer
the difference between the demand and supply price at the quota limit
the earnings that accrue to the license-holder from ownership of the right to sell the good
equal to the market price of the license when the licenses are traded
Example: a quota of 8 million rides creates a supply price of $4 (the amount of money the renter of the license is making) and a demand price of $6 (the amount of money the consumer is paying), creating a __________ ___________ of $2 that goes to the owner of the license
the earnings that accrue to the license-holder from ownership of the right to sell the good
equal to the market price of the license when the licenses are traded
Example: a quota of 8 million rides creates a supply price of $4 (the amount of money the renter of the license is making) and a demand price of $6 (the amount of money the consumer is paying), creating a __________ ___________ of $2 that goes to the owner of the license
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Deadweight Loss
answer
the extra cost form a tax in the form of inefficiency that results because the tax discourages mutually beneficial transactions
excess burden
the loss in total surplus that occurs whenever an action or a policy reduces the quantity transacted below the market equilibrium quantity
excess burden
the loss in total surplus that occurs whenever an action or a policy reduces the quantity transacted below the market equilibrium quantity
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Quantity Control Undesirable Effects
answer
create inefficiencies - missed opportunities in the form of mutually beneficial transactions that don't occur
create incentives for illegal activity
create incentives for illegal activity
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Excise Tax
answer
a tax on sales of a good or service
causes the post tax supply price to be higher than the original supply price
shifts the supply curve upward by the amount of the tax and reduces the quantity bought and sold
drives a wedge between the demand price and the original, pre-tax supply price, but the wedge money goes to the city
Example: a $2 tax is placed on taxi drivers, causing the supply curve to shift to the left, created a new, higher demand price and a wedge between the demand price and the original supply price
it doesn't make any difference who officially pays the tax (whether it is a tax on taxi drivers or taxi riders, creates same price effect)
prevents mutually beneficial transactions from occurring, create incentive for illegal activities
decreases supply
causes the post tax supply price to be higher than the original supply price
shifts the supply curve upward by the amount of the tax and reduces the quantity bought and sold
drives a wedge between the demand price and the original, pre-tax supply price, but the wedge money goes to the city
Example: a $2 tax is placed on taxi drivers, causing the supply curve to shift to the left, created a new, higher demand price and a wedge between the demand price and the original supply price
it doesn't make any difference who officially pays the tax (whether it is a tax on taxi drivers or taxi riders, creates same price effect)
prevents mutually beneficial transactions from occurring, create incentive for illegal activities
decreases supply
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Incidence
answer
is a measure of who really pays the tax or bears the burden of the tax
doesn't matter who officially pays the tax (same price effect whether taxi drivers or riders pay the tax officially)
Example: $2 tax on taxi riders causes a $1 increase in the price paid by riders and a $1 decrease in the price received by sellers - the ______________ is the same for buyers and sellers
depends on shapes of the demand and supply curves
doesn't matter who officially pays the tax (same price effect whether taxi drivers or riders pay the tax officially)
Example: $2 tax on taxi riders causes a $1 increase in the price paid by riders and a $1 decrease in the price received by sellers - the ______________ is the same for buyers and sellers
depends on shapes of the demand and supply curves
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Revenue
answer
the ____________ collected by an excise tax is equal to the area of the rectangle whose height is the wedge that tax drives between supply and demand curves, and whose width is the quantity bought and sold under the tax
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Price Ceiling Inefficiencies
answer
inefficiently low quantity (deadweight loss - shortage)
inefficient allocation to customers
wasted resources
inefficiently low quality
black markets
inefficient allocation to customers
wasted resources
inefficiently low quality
black markets
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Price Floor Inefficiencies
answer
inefficiently low quantity (deadweight loss - surplus)
inefficient allocation of sales among sellers
wasted resources
inefficiently high quality
temptation to break the law by selling below the legal price
inefficient allocation of sales among sellers
wasted resources
inefficiently high quality
temptation to break the law by selling below the legal price
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Inefficiently Low Quantity
answer
price floor reduces the quantity demanded below the market equilibrium quantity and leads to deadweight loss
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Quantity
answer
if sellers don't want to sell as much as buyers want to buy, it is the sellers who determine the actual quantity sold
if buyers don't want to buy as much as sellers want to see, it is the buyers who determine the actual quantity sold
if buyers don't want to buy as much as sellers want to see, it is the buyers who determine the actual quantity sold
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Quantity Control Inefficiencies
answer
deadweight loss because some mutually beneficial transactions don't occur
incentives for illegal activities
incentives for illegal activities
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