Price & Quantity Controls

Purpose of Controls

Even when a market is efficient, governments often intervene to pursue greater fairness or to please a powerful interest group. Interventions can take the place of price controls, or quantity controls.

I. Price controls

Price controls-when government intervenes to control price. Two types:• price ceiling-a maximum price sellers are

allowed to charge for a good or service, or an upper limit.

• price floor-a minimum price buyers are required to pay for a good or service, or a lower limit

A. Price ceilings

• Typically imposed during crises-”price gouging” for example. During WWII, the US govt imposed many price ceilings on goods.

• There are few govt price ceilings today. Rent control in NYC is one example.

Yadayadayadaecon

Effects of a price ceiling:

To be effective (binding) , price ceilings must be set below Pe.

Equilibrium: Qe = 5, Pe=$ 5Consumers are enraged at this high price and successfully lobby for a law that says you can’t sell tacos for more than $3. This is good, right?

Price per taco Q of tacos demanded Q of tacos supplied

$1 9 1

$3 7 3

$4 6 4

$5 5 5

$7 3 7

$9 1 9

1. Shortage-where Qd >Qs

If Pc is $3, Qd = 7 & Qs = 3. Therefore, there is a shortage of 4. Too few of a good will be available.

Price per taco Q of tacos demanded Q of tacos supplied

$1 9 1

$3 7 3

$4 6 4

$5 5 5

$7 3 7

$9 1 9

2. Market Inefficiencies

Governmental price controls often lead to inefficiencies-lost opportunities for both buyers and sellers. Deadweight loss is the lost gains associated with transactions that do not occur due to market intervention.

a. Inefficient allocation to consumers

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 are only willing to pay a relatively low price to get it.

A market is inefficient if there are missed opportunities.

b. Wasted Resources

People expend money, effort, and time to cope with the shortages caused by the price ceiling. Price controls often create missed opportunities where consumers could better use their time/ money if there was efficiency.

c. Inefficiently low quality

Sellers offer low-quality goods at a low price even though buyers and sellers would rather have a higher quality and pay for it.

Sellers have no incentive to provide a better product bc they cannot raise prices but are able to find consumers easily.

d. Black markets

A black market is one in which goods or services are bought and sold illegally.

Summary

Price ceilings are enacted because

1. They do benefit some consumers. Consumers may have the political clout to persuade government that the equilibrium price is taking advantage of them.

2. When they have been in effect for a long time, buyers may not have a realistic idea of what would happen without them.

3. Government officials often do not understand supply and demand analysis.

B. Price Floors

When governments intervene to push prices up instead of down. Typically legislated for agricultural products in the US. Most common price floor is the minimum wage.

Effects of a price floorIf Pe is considered “too low,” a price floor is set above the equilibrium price. A price floor set below the equilibrium price has no effect.

Equilibrium: Qe = 5, Pe =$5Producers are enraged at this low price and successfully lobby for a law that says you can’t sell tacos for less than $7.This is good for sellers, right?

1. Surplus-where Qs >Qd

Binding price floors lead to excess supply.

At Pf=$7, Qs= 7, Qd = 3, so there is a surplus of 4 tacos. Too much of a good will be available.

2. Market Inefficiencies

Governmental price controls often lead to inefficiencies-lost opportunities for both buyers and sellers. Deadweight loss is the lost gains associated with transactions that do not occur due to market intervention.

a. Inefficiently low quantity- Since a price floor raises the price of a good to consumers, quantity demanded falls, so the quantity bought and sold falls.

b. 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.

c. Wasted resources-to combat surpluses, sometimes governments buy unwanted goods. Sometimes, these goods go unused and are destroyed.

d. Inefficiently high quality-Sellers offer high-quality goods at a high price, even though buyers would prefer a lower quality at a lower price.

summary

So why are there price floors? • Legislators believe the relevant market is unfair • Legislators are influenced by powerful sellers • Legislators may not understand the supply and

demand model

Quantity Controls

A quantity control, or quota is an upper limit on the amount of a good able to be sold.

Governments often control quantities through the issuance of licenses.

Why quotas? • To combat potential shortages(agricultural

quotas)• Environmental concerns (hunting/ fishing

quotas; limits on autos/ taxis) • To maintain price levels (OPEC’s limit on crude

oil)

• The demand price of a given quantity is the price at which consumers will demand that quantity.

• The supply price of a given quantity is the price at which producers will supply that quantity.

• Pe; Qe= equilibrium • Qq= quantity quota• Ps= supply price• Pd= demand price

Quotas are only effective if they are set below

equilibrium quantity Qq Qe

Pe

S

D

Pd

Ps

• A quota drives a wedge between what the demand price and the supply price of a good.

• This wedge is also called the quota rent which represents the earnings that accrue to the holder of a license.

Wedge=a +b on graph

consumer & producer surplus

Consumer surplus is the difference between the total amount that consumers are willing and able to pay for a good or service and the total amount that they actually pay. ($ left over)

Producer surplus is the difference between what producers are willing and able to supply a good for and the price they actually receive. (excess profit)

Effects of quotas

1.Deadweight loss-inefficiency resulting from lost opportunities. Prevents some mutually beneficial transactions from occurring.

$7.00

$6.50

$6.00

$5.50

$5.00

$4.50

$4.00

$3.50

$3.00

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9

8

7

6

6

7

8

9

10

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12

13

14

Quantity of rides(millions per year)

Fare(per ride)

Quantity supplied

Quantity demanded

A

B

6 70 8 9 10 11 12 13 14

$7.00

6.50

6.00

5.50

5.00

4.50

4.00

3.50

3.00D

S

E

Deadweight loss

The wedge

Quota

Quantity of rides (millions per year)

Fare

(per ride)

Effect of a Quota on the Market for Taxi Rides

Quantity Controls

Effects of quotas, cont.

3. Illegal activities-quantity controls provide an incentive for people to break the law. Ex., take bribes, poaching, working “off the books,” etc.