Download Price Floors

Modern Principles:
Macroeconomics
Tyler Cowen
and Alex Tabarrok
Price Ceilings and
Price Floors
Slide 1 of 36
Copyright © 2010 Worth Publishers • Modern Principles: Macroeconomics • Cowen/Tabarrok
Price Ceilings
• Price controls create price ceilings when
•
the controlled price is below the market
equilibrium price.
Price ceilings create important
consequences:
1. Shortages
2. Reductions in product quality.
Slide 2 of 36
Price Ceilings
1. Shortages
Price ($)
Results:
1.At the controlled price Qs < Qd
2.In 1973, there were shortages of
wool, copper, aluminum, vinyl,
Supply
denim jeans, paper, …
Market
equilibrium
Controlled price
(ceiling)
Shortage
Demand
Quantity supplied
at the controlled price
Quantity demanded Quantity
at the controlled price
Slide 3 of 36
Price Ceilings
2. Reductions in Product Quality
 One way to evade the law is to cut quality.
 Examples from the 1970s:
• Books were printed on lower quality paper.
• 2" X 4" lumber shrank to 1⅝" X 3⅝"
• New automobiles were painted with fewer
coats of paint.
 Another way quality can fall is to cut service.
 Examples from the 1970s
• The full service gasoline state disappeared.*
• Gasoline stations would close whenever the
owner wanted a break.
Slide 4 of 36
CHECK YOURSELF
Since World War II, New York City has had
rent control, with ceilings placed on the rent
that apartment landlords can charge. You
are moving to New York City. Will you find
a surplus or shortage of apartments?
Some landlords in New York City demand
that new tenants pay $500 or $1000 key
money: landlords will not hand over a set of
apartment keys until this non-refundable
payment is made. How does key money fit
in our model of the effects of price ceilings?
Slide 5 of 36
CHECK YOURSELF
In rent-controlled New York City, over
time, what do you think will happen to
the upkeep of the rent-controlled
buildings? What is the landlord’s
incentive structure?
Slide 6 of 36
Price Floors
• A price floor is a minimum price allowed by
•
•
law.
The best example of a price floor is the
minimum wage.
Price floors create an important effect:
Surpluses.
Slide 7 of 36
Price Floors
1.Surpluses
 Minimum wage leads to a surplus of labor
(unemployment).
 Higher productivity workers are unaffected.
 Minimum wage leads to ↓ employment among
younger workers
• Young people lack skills and experience
• More than half of minimum wage workers are
younger than 25 years old.
 The following diagram shows the effect of a
price floor (minimum wage)
Slide 8 of 36
Price Floors
1.Surpluses (cont.)
Wage
($)
Minimum wage
(floor)
Market wage
Labor surplus
Supply
(Unemployment)
Conclusion: the
greater the
difference
between the
minimum wage
and the market
wage, the greater
is unemployment
Demand
Quantity demanded Market
Quantity supplied Quantity
at minimum wage employment at minimum wage
Slide 9 of 36
CHECK YOURSELF
The European Union has a minimum legal
price for butter, a price floor, that is often
above the market equilibrium price. What
do you think has been the result of this?
The U.S. has set a price floor for milk
above the equilibrium price. Has this led to
shortages or surpluses? How do you think
the U.S. government has dealt with this?
(Hint: remember the cartons of milk you
had in grammar school and high school?
What was their price?
Slide 10 of 36
Takeaway
• You should be able to:
 draw a diagram showing the price ceiling and
correctly labeling the shortage
• You should also understand how price
ceilings…
 Reduce product quality.
 Cause shortages.
Slide 11 of 36
Takeaway
• Using the tools of supply and demand you
should be able to…
 Explain why a price floor creates a surplus.
 Label these areas on a diagram.
Slide 12 of 36