Public Policy Analysis

MPA 404 Lecture 29

Podcast: BBC podcast about GDP

Previous Lecture Brief

o Started with the graphical analysis of everyday policies

o Price changes and its effects

o The SE, IE and TE; normal and inferior goods

o Graphical analysis of price change

o The case of price change in electricity or petroleum

o The podcast about GDP as a measure of well being.

o Analysis of everyday policies continued. The case for school vouchers as an improvement towards better outcomes for education.

o Price Floors : Sets a minimum limit beneath which a product cannot sell. In terms of wages, it is a wage below which a wage cannot be paid. What’s the economic effect of setting a price floor? First, a graphical presentation of what happens.

o The end result is that there is oversupply. But notice that we’ve considered everything as homogeneous here (products and labor). In reality, a lot depends upon the relative elasticity's of demand and supply. For example, the demand for highly skilled labor (like good computer programmers) tends to be inelastic (meaning they are not easily substitutable). So the difference in their case will be that the reduction in demand would be much less compared to ordinary labor.

o Price Ceilings: It’s a maximum limit upon the price. In other words, a higher price than a price ceiling cannot be charged. Let’s graphically depict what happens.

o Graph

o Besides the deadweight loss and the shortage created by these kinds of ceilings, there are other side effects. In addition to the misallocation of resources (too few units and units not allocated to those who value them the most), price ceilings tend to encourage illegal trade as people attempt to exploit the prohibited gains from trade. For example, it became common practice in New York (where a price ceiling on apartments was applied) to attempt to bribe landlords to offer rent-controlled apartments, and such bribes could exceed $50,000. In addition, potential tenants expended a great deal of time searching for apartments, and a common strategy was to read the obituaries late at night when the New York Times had just come out, hoping to find an apartment that would be vacant and available for rent (taken from McAfee’s Econ textbook).

o An important and undesirable by-product of price ceilings is discrimination. In a free or unconstrained market, discrimination against a particular group, based on race, religion, or other factors, requires transacting not based on price but on another factor. In contrast, with a price ceiling, there is a shortage; and sellers can discriminate at lower cost, or even at no cost. That is, if there are twice as many people seeking apartments as there are apartments available at the price ceiling, landlords can “pick and choose” among prospective tenants.