Download Price Ceilings and Price Floors

Bellringer
• What should happen to the equilibrium price
of whoopee cushions when the price of the
rubber necessary to make the cushions
declines?
• A) The equilibrium price will rise.
• B) The equilibrium price will fall.
• C) The equilibrium price will stay the same.
• D) The price of substitute products will rise.
Price Ceilings and Price Floors
Let’s Review!
A forest fire occurs that burns millions of
acres of timber. What happens to the market
for ballpoint pens?
Pulp Wood
Pulp Wood
Your market is:
Paper
Ballpoint pens
Ballpoint Pens
The economy moves out of the recession into
a boom period. What happens to the market
for secondhand clothing?
Your market is:
Secondhand Clothing
Are taxicab rides in New York City
expensive or inexpensive in relative terms?
Real World Example (Oct. 2011)
• Demand outstrips supply I: Two New York taxi medallions – aluminum plates that
grant the right to operate a yellow cab – have changed hands for a record-high $1
million apiece, the New York Times reports.
– Since the city of New York issued its first batch of medallions in 1937 at $10
each ($157.50 in current dollars), their value has continued to grow rapidly,
while the number of medallions available for purchase has been tightly
controlled.
– The city has more than 8 million residents and just 13,237 taxi medallions.
• Demand outstrips supply II: The city of Atlanta, population 420,000, limits the
number of taxi medallions to 1,600; there were 1,558 assigned in 2010 to 23
licensed taxicab companies, according to taxi litigation specialists Taxi Risk.
– Taxi drivers must be affiliated with a taxi company licensed by the city; to be
licensed, a company must own or lease at least 25 medallions, known as
Certificates of Public Necessity and Convenience.
– The published price for a medallion is $6,000, but historically high demand
causes the city to put available medallions through a bid process.
– Taxi Risk puts the average published price paid in 2010 for a medallion at
$36,958; the highest was $60,000
Why do Chicago garbage workers make
$80,000 a year?
Why do college professors
make over $100,000 a year?
Price Ceiling Defined
• A legal maximum on the price at which a good
can be sold
– Rent Control
– Gasoline in the 1970s
• Seems like it would be good for consumers,
but why is it not?
P
S
$1,600
Pc are set
BELOW the
equilibrium
price.
P
D
Q
Pcis the
highest price
that can be
charged in the
market.
Q
Fair market price of apartments in NYC is $1,600
NYC has rent controls which are price ceilings. Where do you think price CEILINGS are set?
BELOW or ABOVE the market price?
P
S
$1,600
P
Pc
$1,200
D
Q
Rent controls are a price set by the government to
keep prices of apartments down. In NYC the
government sets the HIGHEST PRICE that can be
charged for a one-bedroom apartments at $1,200.
Landlords cannot charge above this price.
Q
P
S
$1,600
P
Anytime
Qd > Qs
there is a
SHORTAGE
in the
market.
Pc
$1,200
D
Qs
Q
Q
<
Qd
Looking at the graph, what occurs when the price is
set BELOW the equilibrium price when a PRICE
CEILING is set?
The Quantity Demanded > the Quantity Supplied
Q
This is the number
of apartments landlords
are willing to supply at
this price (Qs).
This is the number of
people willing to
rent apartments at
this price (Qd).
S
P
$1,600
P
Pc
$1,200
D
Qs
This is a SHORTAGE.
<QQ
Qd
Q
P
S
$1,600
P
Pc
$1,200
D
Qs
<QQ
Qd
Q
_________ is looking for an apartment in NYC. Are they going to find one?
PRICE CEILING—THE HIGHEST PRICE THE
SELLER CAN SELL THE
PRODUCT.
P
$1,600
S
P
Pc
$1,200
D
Qs
<QQ
Qd
Q
Rent Control in the Short Run and in the Long Run
(a) Rent Control in the Short Run
(supply and demand are inelastic)
Rental Price of Apartment
(b) Rent Control in the Long Run
(supply and demand are elastic)
Rental Price of Apartment
Supply
Supply
Controlled rent
Controlled rent
Shortage
Demand
Demand
Shortage
0
Quantity of Apartments
0
Quantity of Apartments
27
Garth Brooks Concert
• When Garth Brooks came to Atlanta many years
ago, he wanted to make it a tribute to his fans and
make sure they could afford the concert.
• Economists say the going rate for a Garth Brooks
ticket in ATL is $124 per ticket. Thought this was
too expensive so he said no one could charge
more than $17 per ticket.
• Draw a S & D graph showing what will happen.
Price Floor Defined
• A legal minimum on the price at which a good
can be sold
– Agricultural products
– Minimum wage
To fly from Chicago to
Minneapolis it cost
In 1975
Minneapolis
San
Fran.
$169
Chicago
$69
Los Angeles
To fly from Los Angeles
to San Francisco it cost
WHY?
In 1975
This is INTERSTATE
travel.
Minneapolis
San
Fran.
This is INTRASTATE
$169
travel. (inside the state)
Chicago
$69
Los Angeles
P
S
Pf
P
D
Q
Q
Interstate travel was regulated by the Civil
Aeronautics Board. It set the prices for flights
traveling across state lines. It set a PRICE FLOOR.
Where is a PRICE FLOOR set? Above or BELOW
the equilibrium price? ABOVE.
P
S
Pf
P
D
Q
Q
Why is it called a price FLOOR if it is set ABOVE
the equilibrium/market price?
Because it is the LOWEST price that can be charged
by law.
S
P
$169
$69
Pf
P
$169
D
$69
Q
Q
Which route is the market price and which route
is the PRICE FLOOR?
The market price is $69, the price charged between
Los Angeles and San Francisco.
The PRICE FLOOR is $169, the price charged
between Chicago and Minneapolis.
$169
$69
S
P
Whenever there is $169
a PRICE FLOOR
$69 P
the Quantity
Supplied is
greater than the
Quantity Demanded.
Pf
D
Qd Q< Qs
Q
$169
$69
P
Qd of Qs of
seats < seatsS
$169
A price floor
causes a
SURPLUS
in the market.
$69
Pf
P
D
Qd Q< Qs
Q
$169
$69
Pf
P
D
Qd Q< Qs Q
What price did the airlines charge customer flying
from Chicago to Minneapolis? $169
If airlines couldn’t compete by price since they
all charged the same price, how did airlines compete?
Service: Best food, bigger seats, prettiest flight
attendants.
http://www.1jetsettravel.com/Picts/22Plncbn.jpg
Surplus of seats
available because
of the price floor.
http://www.transport-pf.or.jp/english/sky/airplane/exploration/img/jal-mesi.jpg
Airlines competed by
serving better food.
Prettiest stewardess
But now, since they don’t
have to compete as hard for
your business…
As deregulation of the airline industry took
place in 1978, what happened to the price
floor?
S
P
$169
$69
Pf
P
D
Qd
Q
Qs
Q
As deregulation of the airline industry took
place in 1978, what happened to the price
S
P
floor?
$169
$69
Pf
P
D
Qd Q Qs Q
The price floor is eliminated, lowering the price to the
market price. This gets rid of the surplus. People get
to fly for lower prices, but the airplanes are now more
crowded.
S
$5
D
D
40,000
The Toledo arena holds a maximum of 40,000
people, as indicated in the graph above. Each
year the circus holds eight performances, all of
which are sold out.
(a) Analyze the effect on each of the following
of the addition of a fantastic new death-defying
trapeze act that increases the demand for tickets.
(i) price of tickets (ii) quantity of tickets sold
S
$5
D
40,000
(b) The city of Toledo institutes an effective price
ceiling on tickets. Explain where the price ceiling
would be set.
Explain the impact of the ceiling on each of the
following.
(i) The quantity of tickets demanded
(ii) The quantity of tickets supplied
S
$5
D
40,000
(c ) Will everyone who attends the circus pay the
ceiling price set by the city of Toledo? Why
or why not?
S
$5
D
D
40,000
The Toledo arena holds a maximum of 40,000
people, as indicated in the graph above. Each
year the circus holds eight performances, all of
which are sold out.
(a) Analyze the effect on each of the following
of the addition of a fantastic new death-defying
trapeze act that increases the demand for tickets.
(i) price of tickets (ii) quantity of tickets sold
P1
$5
S
This new act causes the Demand
curve to shift to the right,
D1 causing price to go up
and quantity to remain the same.
40,000
(a) Analyze the effect on each of the following
of the addition of a fantastic new death-defying
trapeze act that increases the demand for tickets.
(i) price of tickets
(ii) quantity of tickets sold
S
$5
D
Pc
40,000
(b) The city of Toledo institutes an effective price
ceiling on tickets. Explain where the price ceiling
would be set.
The price ceiling is set below the equilibrium P
of $5.
S
$5
Pc
D
40,000 Qd1
(b) Explain the impact of the ceiling on each of the
following.
(i) The quantity of tickets demanded
The quantity of tickets demanded increases.
S
$5
Pc
D
40,000 Qd1
(b) Explain the impact of the ceiling on each of the
following.
(ii) The quantity of tickets supplied
The quantity of tickets supplied remains the same.
S
$5
Pc
D
40,000 Qd1
(c ) Will everyone who attends the circus pay the
ceiling price set by the city of Toledo? Why
or why not?
No, a secondary market (black market) occurs.
Scalpers will get higher prices because Qd >Qs.
ACTIVE LEARNING
1
Price controls
P
140
Determine
effects of:
A. $90 price
ceiling
130
The market for
hotel rooms
S
120
110
100
90
B. $90 price
floor
80
C. $120 price
floor
60
D
70
50
40
0
Q
50 60 70 80 90 100 110 120 130
1
ACTIVE LEARNING
A. $90 price ceiling
The price falls
to $90.
Buyers
demand
120 rooms,
sellers supply
90, leaving a
shortage.
The market for
hotel rooms
P
140
130
S
120
110
100
Price ceiling
90
80
shortage = 30
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
ACTIVE LEARNING
1
B. $90 price floor
Eq’m price is
above the floor,
so floor is not
binding.
P = $100,
Q = 100 rooms.
The market for
hotel rooms
P
140
130
S
120
110
100
90
80
Price floor
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
1
ACTIVE LEARNING
C. $120 price floor
The price
rises to $120.
Buyers
demand
60 rooms,
sellers supply
120, causing a
surplus.
P
140
130
120
The market for
hotel rooms
surplus = 60
S
Price floor
110
100
90
80
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
Practice Question
1. Assume that the market for doodads has an
equilibrium price of $10. At this price suppliers
produce 1,000 units.
A. Draw a supply and demand graph illustrating the
market doodads. Indicate equilibrium price and
quantity on your graph.
B. The government imposes a maximum price of $12 on
the price of doodads. Explain the effect on the
equilibrium price that this price ceiling will have?
C. Now assume that the government imposes a
minimum price of $12 on the price of doodads.
Illustrate this price control on your graph.
D. Determine whether a shortage or surplus is created.
Indicate the quantity of this shortage or surplus.
Practice Question
2. Assume that there is a perfectly inelastic
supply of krypton power and that 1,000,000
units of power are produced. The equilibrium
price of a unit of kryptonpower is $4.
A. Draw a graph of the market for krypton power.
Illustrate the equilibrium price and quantity on
your graph.
B. Assume that an effective price ceiling is
established at a price of $3. Illustrate this price
ceiling on the graph.
C. Explain the affect on output created by the price
control.