Microeconomics: Chapter 5

Distorted price signals cause resources to be misallocated. If prices are distorted, they cannot give good information to buyers and sellers.

Legal restrictions on how high or low a market price may go. Two main types: price ceiling, price floor

A maximum price sellers are allowed to charge for a good or service (usually set BELOW equilibrium)

A minimum price buyers are required to pay for a good or service (usually set ABOVE equilibrium)

If a price ceiling is set above equilibrium, it will have no effect - Nonbinding

Only a price ceiling that forces price below equilibrium will have any effect (called binding or effect) --> causes a shortage.

If it is the price that changes first, it is a shift ALONG the demand/supply curve.
Price has already become a variable in your equation.

The movement along a demand curve happens when the only factor that changes is price. The shift of the demand curve is actually caused by any actual changes in the determinants of the demand. (Shift of a demand/supply curve is because of any reason other than price)

Inefficiently low quantity
Inefficient allocation to customers
Wasted resources
Inefficiently low quality
Black markets

When prices are held below the market price, shortages are created.

The lower the controlled price relative to the market equilibrium price, the larger the shortage.

Price controls distort signals that would help the goods get allocated their highest-valued uses.
- Consumers who value a good most don't necessarily get it.
- So producers have no incentive to supply the good to the "right" people first.
* As a result, good are misallocated.

The first person willing to pay get its, but it doesn't necessarily mean someone who values it more will get it (may offer 1800 vs. normal 800 but you can't sell it!) if you always have to go off the idea of first come first serve, you're going to spend a lot of time waiting in line.

Price controls that create shortages lead to bribery and wasteful lines.
Shortages - not all buyers will be able to purchase the good.
Normally, buyers would compete with each other by offering a higher price.
If price is not allowed to rise, buyers must compete in other ways (waiting in line, illegal bribes and favors)

At the controlled price, sellers have more customers than goods.

In a free market, this would be an opportunity to profit by raising prices. - But when prices are controlled, sellers cannot.
Sellers respond to this problem in two ways:
- Reduce quality
- Reduce service

When did full service gas stations go away? During the price ceilings in the 1970s

A black market is a market in which goods or services are bought and sold illegally - either because they are prohibited or because the equilibrium price is illegal.

Wasted resource - wasting the time that you could have spent doing something else.

Inefficient allocation of goods

They do benefit some people (who are typically better organized and more vocal than those who are harmed by them)

If the price ceiling 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.

Sometimes governments intervene to push market prices up instead of down. (Minimum prices)
Ex: the generous minimum wage in many European countries has contributed to a high rate of unemployment and the flourishing of an illegal labor market

If a price floor is set below equilibrium, it will have no effect (called nonbinding).

Only a price floor that forces price above equilibrium will have any effect

Price floors cause predictable side effects:
- Deadweight loss from inefficiently low quantity
- Inefficient allocation of sales among sellers
- Wasted resources
- Inefficiently high quality
- Temptation to break the law by selling below the legal price

Surplus

The lower quantity of quantity demanded and quantity supplied - the lower cost will determine which will be the quantity transacted.

Price floors misallocate sales by:
- allowing high-cost firms to operate.
- preventing low-cost firms from entering the industry.
This may stop cost-efficient producers from entering the market.

Price floors and regulation prevented Southwest (and 79 other firms) from entering the national market.

Price floors encourage waste.
To deal with the surplus generated by agricultural price floors, the US government sometimes buys back the excess and donates or destroys it.

Higher quality raises costs and reduces sellers' profit.
Buyers get higher quality but would prefer a lower price.
Price floors encourage sellers to waste resources: higher quality than buyers are willing to pay for it.

Ex: most flyers prefer a lower ticket price (with no food included) than an expensive ticket with expensive/fancy food

Price floors encourage black markets.
There are willing sellers (and buyers) at illegal prices, so they are tempted to break the law and trade with each other.

Same as price ceilings:
They do benefit some people (who are typically better organized and more vocal than those who are harmed by them)

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

Governments sometimes control quantity instead of price

an upper limit, set by the government, on the quantity of some good than can be bought or sold; also referred to as a quantity controlled

the total amount of a good under a quota or quota control that can be legally transacted

the right, conferred by the government, to supply a good

A price ceiling - pushes the price of a good down; fewer sellers will want to sell
A price floor - pushes the price of a good up; fewer buyers will want to buy
A quota, by definition, reduces sales

If sellers don't want to sell as much as buyers want to buy, it's the sellers who determine the actual quantity sold, because buyers can't force unwilling sellers to sell and vice versa

the price of a given quantity at which consumers will demand that quantity

the price of a given quantity at which producers will supply that quantity

The difference between the demand price and the supply price at the quota limit. Equal to the market price of the license when the license is traded.

1/2 (the wedge x [the equilibrium price - quota)

Like price controls, quotas impose losses on society
- Deadweight loss (some mutually beneficial transactions don't occur)
- Incentives for illegal activities