Market Interventions: Ceilings & Floors

AP EconomicsUniversity High2012-2013

Overview In a competitive market, price will

adjust until quantity supplied equals quantity demanded.

However, sometimes government feels the need to intervene in the market and prevent equilibrium from being reached Usually done with good

intentions in mind However, interventions result in

undesired secondary effects Interventions usually in the form

of price floors or price ceilings

Marginal Buyers & Sellers Marginal buyers: Individuals on

demand curve that are not willing/able to pay market price

Marginal suppliers: Firms on supply curve not willing/able to supply at market price

Pareto Optimum

“Pareto Optimum” Optimal level of tradeoff Not going to get more surplus Maximizing Efficiency What happens when you disturb pareto

optimum?

Price Ceilings Price Ceiling: A legal maximum on the

price at which the good can be sold Below the equilibrium price if binding▪ Significant effect

Above the equilibrium price if non-binding ▪ No measurable effect

Which side appears happier?

Raise the Roof!

1973 Oil Crisis

1973 Oil Crisis

1973 Oil Crisis

1973 Oil Crisis

1973 Oil Crisis

1973 Oil Crisis

1973 Oil Crisis

1973 Oil Crisis

Some other form of rationing mechanism has to step in when price is unable to regulate market The true price of gasoline, which included both the cash

paid and the time spent waiting in line, was often higher than it would have been if the price had not been controlled.

In 1979 the United States fixed the price of gasoline at about $1.00 per gallon.

If the market price had been $1.20, a driver who bought ten gallons would apparently have saved $.20 per gallon, or $2.00.

But if the driver had to wait in line for thirty minutes to buy gasoline, and if her time was worth $8.00 per hour, the real cost to her was $10.00 for the gas and $4.00 for the time, an overall cost of $1.40 per gallon. 

Rent Control

Rent Control

Price Floors Sets a legal minimum price for a good or service

Binding if ______the equilibrium Implemented to help ________ Provides suppliers with a price _______than the

original market equilibrium

Price floors, set above the equilibrium price, result in a ____ in the market Surplus – Quantity supplied exceeds quantity

demanded

Price Floors

Price Floors Decision to intervene in the market is a normative decision

Why? Because policy makers are making decisions based on value

judgments▪ Is the benefit to those receiving a higher wage greater than

the added cost to society?▪ Is the benefit of having excess food production greater than

the additional costs that are incurred due to the market intervention?

Price Floors A common price floor is the implementation of a minimum wage Labor market

Firms demand labor Workers supply labor

If market equilibrium set above equilibrium price for labor, some of those not able to work at original equilibrium price are now willing to supply labor at higher wage Increase in quantity of labor supplied Firms must pay more for labor and thus reduce the quantity of

labor demanded The result is a surplus of labor at new price (minimum

wage rate) Price is no longer the rationing mechanism in market Individuals willing and able to work at or below the minimum

wage rate might not be able to get a job