Micro Economics- The Power of Prices-2

8/3/2019 Micro Economics- The Power of Prices-2

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Part 2The Power of Prices

Part 2The Power of Prices

Microeconomics

Prof. Rushen Chahal

2/12/20122/12/2012 Prof. Rushen ChahalProf. Rushen Chahal


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FurtherFurther--

Price ceilingsPrice ceilings Price floorsPrice floors

Price supportsPrice supports

Minimum wageMinimum wage

Black marketsBlack markets



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Consider the following:Consider the following:

Housing prices in Beijing are rising rapidly.Housing prices in Beijing are rising rapidly.

Some might be concerned that rent may oneSome might be concerned that rent may oneday become prohibitively expensive.day become prohibitively expensive.

One possible solution is aOne possible solution is a price ceilingprice ceiling, which, which

would set a maximum limit on the amount awould set a maximum limit on the amount alandlord can rent out his property.landlord can rent out his property.

But does it really work . . . ? NO!!! It has badBut does it really work . . . ? NO!!! It has bad

sideside--effects!effects!2/12/20122/12/2012 Prof. Rushen ChahalProf. Rushen Chahal


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PRICE CEILINGSPRICE CEILINGS HOLDING PRICESHOLDING PRICES

DOWNDOWN Price Ceiling: a law that restricts a

price from rising above a certain level

Rent Controls: a price ceiling on rented homes (for

example, apartments)



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Price CeilingsPrice Ceilings

Millions of Dwellings

Rented per Month

$

$2000

$1200

Equilibrium price

Ceiling Price

2.5 3.5

3

Quantity Supplied Quantity Demanded

Equilibrium Quantity

A shortage is created



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Rented per Month

$

$2000Equilibrium price

3


Before Rent Control

ConsumerSurplus

Producer

Surplus



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Rented per Month

$

$1200

A deadweight is created

Quantity

Supplied

ProducerSurplus

Ceiling Price

ConsumerSurplus

DeadweightLoss



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Rented per Month

$

$1200Ceiling Price

Tanisha is willing to pay $2500for an apartment

$2500

Candice is willing to pay $1300for an apartment

Tanishas benefit from

renting an apartment

Candices benefit fromrenting an apartment

$1300



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Rented per Month

$

$1200Ceiling Price

Tanishas benefit from rentingan apartment is clearly more

than Candices, as shes willingto pay more. So there is moresocial benefit ifTanisha getsthe apartment.






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Rented per Month

$

$1200Ceiling Price

Tanisha can NOT pay a higher

price than $1,200, so CandiceMIGHT get to rent theapartment. If Candice gets theapartment, it is INEFFICIENT.






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Price CeilingsPrice Ceilings -- conclusionconclusion

Price ceilings (including rent control)Price ceilings (including rent control)

Cause shortagesCause shortages

Cause a deadweight lossCause a deadweight loss

Cause inefficient allocationCause inefficient allocation



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Consider the followingConsider the following

In America, 2% of the population are farmersIn America, 2% of the population are farmers They provide food to the other 98% of theThey provide food to the other 98% of the

populationpopulation Some people worry that if the price of foodSome people worry that if the price of food

becomes too low, these farmers will not be ablebecomes too low, these farmers will not be ableto liveto live

The government could protect these farmers byThe government could protect these farmers byimplementing a minimum price people can payimplementing a minimum price people can paythem for their food, or athem for their food, or a price floorprice floor



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PRICE FLOORS (a MINIMUM price)PRICE FLOORS (a MINIMUM price)

Price floors are used by governments tokeep prices above equilibrium. Producers

like them because they make moremoney.



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Price FloorsPrice Floors

Tons/Corn supplied/year

$

$10

$7Equilibrium price

Price Floor

40 60

50

Quantity Demanded Quantity Supplied


A surplus is created



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$

$7Equilibrium price

50

Quantity Supplied


Before Price Floors

ConsumerSurplus

ProducerSurplus



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$

$10Price Floor

After implementing a price floor

OriginalEquilibrium

LessConsumed

MoreProduced

Deadweight LossFrom reduced

consumption

Deadweight LossFrom increased

production



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Price FloorsPrice Floors A price floor causes:A price floor causes:

a surplusa surplus

a deadweight lossa deadweight loss

a lower quantity than the equilibrium quantitya lower quantity than the equilibrium quantity

waste:waste: The government must use taxpayer money to pay for theThe government must use taxpayer money to pay for the

surplus. It then must store or destroy the surplus. Whysurplus. It then must store or destroy the surplus. Whycant it sell the surplus?cant it sell the surplus?

The government must keep the surplus out of the marketThe government must keep the surplus out of the marketso that consumers must buy from producers.so that consumers must buy from producers.2/12/20122/12/2012 Prof. Rushen ChahalProf. Rushen Chahal


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Black MarketsBlack Markets

Black markets are markets where goodsBlack markets are markets where goodsare bought and sold illegallyare bought and sold illegally

Goods bought and sold in black marketsGoods bought and sold in black marketsare not subject to price controls set by theare not subject to price controls set by thegovernmentgovernment

Wherever price controls exist, you will findWherever price controls exist, you will findblack marketsblack markets



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For example: cities with rent controlFor example: cities with rent control

Prospective tenants will often bribe landlordsProspective tenants will often bribe landlordswith money or gifts to get them to rent towith money or gifts to get them to rent tothemthem



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Black markets can be seen as the free marketBlack markets can be seen as the free markettrying to assert itselftrying to assert itself

Government controls are causingGovernment controls are causingshortages/surpluses and inefficienciesshortages/surpluses and inefficiencies Black markets are simply trying to erase theseBlack markets are simply trying to erase these

problems created by government policyproblems created by government policy

Black Markets act as a safety net and provideBlack Markets act as a safety net and providepeople in countries where they exist withpeople in countries where they exist withnecessities they would otherwise have to donecessities they would otherwise have to dowithout.without.


Micro Economics- The Power of Prices-2

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