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Chapter 6
PRICE CEILINGS AND
PRICE FLOORS
© 2013 Cengage Learning
Gottheil — Principles of Economics, 7e
1
Economic Principles
Government intervention in markets
Price ceilings
Price floors
Parity pricing
Target prices
Crop limitation programs
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EXHIBIT 1 PRODUCTION POSSIBILITIES CURVE FOR
CIVILIAN AND DEFENSE GOODS
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Exhibit 1: Production Possibilities
Curve for Civilian and Defense
Goods
The production possibilities curve in
Exhibit 1 provides information on:
• The production possibilities curve shows
the possible combination of civilian and
defense goods that could be produced.
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Exhibit 1: Production Possibilities
Curve for Civilian and Defense
Goods
When there is a national security
crisis, the number of civilian goods
produced:
• The production of civilian goods declines as
more defense goods are produced.
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EXHIBIT 2 THE FISH MARKET BEFORE AND AFTER
THE DRAFT
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Exhibit 2: The Market Before
and After the Draft
In Exhibit 2, the community’s
predraft and postdraft demand for
fish does not change.
• Demand for fish doesn’t change just because
there’s a national security problem.
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Exhibit 2: The Market Before
and After the Draft
In Exhibit 2, the community’s
predraft and postdraft demand for
fish does not change.
• Note that the demand curves before and
after the supply curve has shifted are
identical.
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Exhibit 2: The Market Before
and After the Draft
After the draft, the quantity of fish
supplied:
• With fishermen being drafted and fewer
boats in the water, the supply of fish
declines and the supply curve shifts to the
left.
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Exhibit 2: The Market Before
and After the Draft
Postdraft, the equilibrium price of fish:
• The equilibrium price of fish increases from
$4 to $10 after the draft.
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Exhibit 2: The Market Before
and After the Draft
After the draft, the quantity of fish
bought and sold:
• The quantity of fish bought and sold
declines from 10,000 to 7,000 fish.
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Exhibit 2: The Market Before
and After the Draft
The greater burden of the increased
price for fish is felt by:
• The poor
• The rich
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Exhibit 2: The Market Before
and After the Draft
The greater burden of the increased
price for fish is felt by:
• The poor
• The rich
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Exhibit 2: The Market Before
and After the Draft
The greater burden of the increased
price for fish is felt by:
• The increase in the price of fish makes it
unthinkable for the poor to purchase fish,
while the rich hardly notice the increase and
continue to buy fish.
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Price Ceiling
Price ceiling
• A maximum price set by government below
the market-generated equilibrium price.
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EXHIBIT 3 SETTING A $4 PRICE CEILING IN THE
FISH MARKET
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Exhibit 3: Setting a $4 Price
Ceiling in the Fish Market
In Exhibit 3, when a $4 price ceiling
is set, the market for fish:
• When the price ceiling is set at $4, the
quantity of fish demanded increases from
7,000 to 10,000.
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Exhibit 3: Setting a $4 Price
Ceiling in the Fish Market
In Exhibit 3, when a $4 price ceiling
is set, the market for fish:
• Based on the post-draft supply curve, the
quantity of fish supplied falls from 7,000 to
4,000.
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Exhibit 3: Setting a $4 Price
Ceiling in the Fish Market
In Exhibit 3, when a $4 price ceiling
is set, the market for fish:
• Based on the postdraft supply curve, there
is a shortage—an unsatisfied excess
demand—of 6,000 fish.
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Exhibit 3: Setting a $4 Price
Ceiling in the Fish Market
Allocate a shortage of goods:
• One method is through the use of ration
coupons.
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Exhibit 3: Setting a $4 Price
Ceiling in the Fish Market
Allocate a shortage of goods:
• Ration coupons are issued by the government,
entitling the holder to purchase a specific
quantity of a good at or below the price ceiling.
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Exhibit 3: Setting a $4 Price
Ceiling in the Fish Market
Allocate a shortage of goods:
Ration coupons may be issued based on
schemes such as:
• First come, first served
• Household size
• Lottery
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Price Ceiling and Housing
Rent control is a government-set
price ceiling on rent.
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Price Ceiling and Housing
Arguments against rent control:
• It dampens landlords’ incentives to properly
maintain their existing rental units.
• It discourages many people from investing in
new construction.
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Price Floors
Price floor
• A minimum price set by government
above the market-generated equilibrium
price.
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EXHIBIT 4 EFFECT OF NEW TECHNOLOGY ON
THE FISH MARKET
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Exhibit 4: Effect of New
Technology on the Fish Market
When a new technology is adopted,
the supply curve in the fish market:
• The supply curve shifts the the right.
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Exhibit 4: Effect of New
Technology on the Fish Market
After adopting the new technology,
total revenue for the fisherman:
• Total revenue decreases.
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Exhibit 4: Effect of New
Technology on the Fish Market
After adopting the new technology,
total revenue for the fisherman:
• Prior to adopting the new technology,
10,000 fish were sold at an equilibrium price
of $4 each, for a total revenue of $40,000.
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Exhibit 4: Effect of New
Technology on the Fish Market
After adopting the new technology,
total revenue for the fisherman:
• After adopting the new technology, 12,000
fish are sold at an equilibrium price of $2
each, for a total revenue of $24,000.
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EXHIBIT 5 SETTING A $4 PRICE FLOOR IN THE
FISH MARKET
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Exhibit 5: Setting a $4 Price
Floor in the Fish Market
In Exhibit 5, when a $4 price floor is
set, the market for fish:
• The quantity of fish supplied increases from
12,000 to 15,000.
• The quantity of fish demanded declines from
12,000 to 10,000.
• A surplus, or excess supply, of 5,000 fish
is created.
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Exhibit 5: Setting a $4 Price
Floor in the Fish Market
The excess supply of fish can be
dealt with:
• The decision to support a price floor is a
societal matter.
• If the community represented by the
government wants to support the fishermen
through a price floor, then the government
will buy the excess supply.
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EXHIBIT 6 GROWTH OF U.S. AGRICULTURAL
PRODUCTIVITY THROUGHOUT U.S. HISTORY
* Precise data are not available.
Source: James Zelner and R.M. Lamm, “Agriculture’s Vital Role for Us All,” Food—From Farm to Table, 1982
Yearbook of Agriculture, Department of Agriculture, Washington, D.C., p. 3.
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Gottheil — Principles of Economics, 7e
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Exhibit 6: Growth of U.S. Agricultural
Productivity Throughout U.S. History
Agricultural productivity has
increased in the U.S. because:
• Changes in the dominant energy source
technology used on farms.
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Exhibit 6: Growth of U.S. Agricultural
Productivity Throughout U.S. History
Agricultural productivity has
increased in the U.S. because:
• Advances in modern chemistry to produce
fertilizers, insecticides, crop ripeners and food
preservatives.
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EXHIBIT 7 EFFECT OF NEW TECHNOLOGY IN FARMING
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Exhibit 7: Effect of New
Technology in Farming
As new energy source technologies
and modern chemistry increase
productivity and shift the supply
curve to the right, price:
• Price declines with each shift of the supply
curve to the right.
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Parity Pricing
Parity pricing
• Parity pricing describes one criteria used to
determine the level at which a price floor
should be set.
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Parity Pricing
Parity pricing
• It asks for equality between the prices that
farmers have to pay for the goods they buy,
and the prices they get for the goods they sell.
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Parity Pricing
Parity pricing
• Parity pricing was adopted by the
government in 1933 when Congress passed
the Agricultural Adjustment Act.
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EXHIBIT 8
SHOES AND
CORN: SHIFTS
IN DEMAND
AND SUPPLY:
1914–2004
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Exhibit 8: Shoes and Corn: Shifts in
Demand and Supply: 1914-2004
In Exhibit 8, the market for shoes
changes from 1914 to 2004:
• While the supply curve for shoes remained
unchanged, the demand curve for shoes
shifted to the right.
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Exhibit 8: Shoes and Corn: Shifts in
Demand and Supply: 1914-2004
In Exhibit 8, the market for shoes
changes from 1914 to 2004:
• The shift in demand raised the equilibrium
price for shoes from $2 to $4.
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Exhibit 8: Shoes and Corn: Shifts in
Demand and Supply: 1914-2004
The market for corn changed in the
same time period:
• The demand curve for corn remained
unchanged, while breakthroughs in technology
and chemicals shifted the supply curve for corn
to the right.
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Exhibit 8: Shoes and Corn: Shifts in
Demand and Supply: 1914-2004
The market for corn changed in the
same time period:
• The equilibrium price of corn declined from
$2 in 1914 to $1 in 2004.
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Exhibit 8: Shoes and Corn: Shifts in
Demand and Supply: 1914-2004
Parity pricing affects the quantity of
corn demanded and supplied:
• Parity pricing, setting a price floor of $4 for
corn, restores the exchange parity between
corn and shoes.
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Exhibit 8: Shoes and Corn: Shifts in
Demand and Supply: 1914-2004
Parity pricing affects the quantity of
corn demanded and supplied:
• It also creates an excess supply of 50 million
bushels of corn.
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Parity Price Ratio
Parity price ratio
• The relationship between prices received by
farmers and prices paid by farmers.
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EXHIBIT 9
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PARITY PRICE RATIOS OF PRICES RECEIVED
AND PAID BY FARMERS: 1910–2000
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Exhibit 9: Parity Price Ratios of
Prices Received by Farmers and Paid
by Farmers: 1910–2000
Changes in the parity price ratio
since 1910:
• Except for the period between 1910 and 1920
and during the 1940s, the parity price ratio
has been on the decline.
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Freedom to Farm Act of 1996
Freedom to Farm Act of 1996
• Legislation enacted by Congress that
phases in, over a 7-year transitional period,
the complete dismantling of the
government’s farm price support and crop
restriction systems.
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EXHIBIT 10 Farm Bill Legislation: 1933–2008
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The Farm Bill of 2008
Farm Bill of 2008
• The Food, Conservation, and Energy Act of
2008 continues the 2002 Farm Act and likewise
covers income and commodity price support,
land conservation, water and farmland
protection and development of rural renewable
energy sources. The cost of the bill for its
5-year term is about $300 billion.
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Farm Subsidies around
the World
Source: Organization for Economic Cooperation and Development.
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A Long Tradition of Price
Ceilings and Price Floors
Usury
• Originally, the charging of interest on loans,
but it has come to mean the charging of
unreasonably high rates of interest. Usury laws
have been enacted to fix the maximum price of
borrowing money since ancient times.
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