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Prices

Prices. Lesson 16: Upsetting the Rules - Costs & Benefits of Government Price Controls. Readings and Assignments. The Young Economist Chapters 17-18. Rent Seeking, Politics, and Elasticities. •Price controls reduce total producer and consumer surpluses.

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Prices

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  1. Prices Lesson 16: Upsetting the Rules - Costs & Benefits of Government Price Controls

  2. Readings and Assignments The Young Economist Chapters 17-18

  3. Rent Seeking, Politics, and Elasticities •Price controls reduce total producer and consumer surpluses. •Governments institute them because people care more about their own surplus than about total surplus. •Individuals spend money to lobby governments to institute policies that increase their own surplus.

  4. Rent Seeking, Politics,and Elasticities Rent seeking – activities designed to transfer surplus from one group to another. Public choice economists integrate economic analysis of politics with their analysis of the economy. They argue that when all rent seeking and tax consequences are netted out, there is often not a net gain to the public. Price Controls Product Controls

  5. Product Controls • Government regulates the type, amount, or quality of a produced G or S • Licensing • Pasteurized milk • Alcohol sales after 9pm • Blue Laws

  6. Floors and Ceilings Government interference with the market.

  7. Price Floors • A price floor is a government-set price above equilibrium price, a legal minimum price. • •It is a tax on consumers and a subsidy to producers. • •Price floors transfer consumer surplus to suppliers. • An example is the minimum wage or farm price supports. • A price floor creates an excess supply or surplus.

  8. Who is really helped?

  9. Effects of Price Floors C+E, Still Welfare loss Consumer Surplus, A Price Floor Now B+D+F is Producer Surplus Don’t Forget the Surplus that was created as well.

  10. A Price Floor

  11. Price Ceilings • •A price ceiling is a government-set price below market equilibrium price, a legal maximum price. • It is an implicit tax on producers and an implicit subsidy to consumers. • An example is the rent controls. • A price ceiling creates a decrease in supply or shortage.

  12. Who is really helped?

  13. Effects of Price Ceilings! Consumer Surplus, A,B, added D, lost C Welfare Loss, C+E Transferred to Consumers Price ceiling Producer Surplus, lost D and E Don’t Forget the Shortage that was created as well.

  14. Rent Controls

  15. Price Floors and Elasticity of Demand and Supply The surplus created by a price floor is larger if demand and supply are elastic. P P Surplus Surplus D S PF S PF PE PE D QD QS QD QS

  16. The Long-Run/Short-Run Problem of Price Controls • The problem of price controls worsen from the short run to the long run. • In the long run, supply and demand tend to be much more elastic than in the short run. • In the short run there will be small effects from the price controls. • There will be huge effects in the long run.

  17. The Long-Run/Short-Run Problem of Price Controls • In the face of price controls, potential new competitors hate to enter the market thereby strangling supply. • Vacancy rates drop as potential new renters scramble to find shrinking affordable housing. • In the long-run, supply and demand tend to be much more elastic than in the short run. • In the short run, when demand and supply are more inelastic, the effects of price controls are small. • In the long run, with more elastic demand and supply, the shortages or surpluses are larger.

  18. Long-Run and Short-Run Elasticities Short run Supply Price Long run Supply P1 P2 Larger long-run elasticities result in smaller price increases when demand increases. PE D1 D0 QE Q1 Q2 Q3

  19. Given the following demand andsupply of pizza, find consumer and producer surplus. Consumer Surplus: ½ x ($10-6) x 100 = $200 S $10 $9 $8 $7 $6 Producer surplus: ½ x ($6-4) x 100 = $100 $5 $4 D 50 100 150 200 250 300

  20. Given the following demand and supply of pizza, show the effects of a price floor at $8. Consumer Surplus S $10 $9 $8 Price Floor $7 Deadweight Loss $6 Producer surplus $5 $4 D 50 100 150 200 250 300

  21. Government Intervention asImplicit Taxation Government intervention in the form of price controls can be viewed as a combination tax and subsidy. A price ceiling is an implicit tax on producers and an implicit subsidy to producers that causes a welfare loss identical to the loss from taxation. A price floor is a tax on consumers and a subsidy for producers that transfers consumer surplus to producers.

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