Price controls
From Wikipedia, the free encyclopedia
A price control is a law that regulates the price of a good, service, salary, rent, interest rate, or any other kind of price.
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[edit] Price ceilings
A price ceiling is a government-imposed limit on how high a price can be charged on a product. For a price ceiling to be effective, it must differ from the free market price. In the graph at right, the supply and demand curves intersect to determine the free-market quantity and price.
A price ceiling can be set above or below the free-market equilibrium price. In the graph at right, the dashed line represents a price ceiling set above the free-market price, called a non-binding price ceiling. In this case, the ceiling has no practical effect. The government has mandated a maximum price, but the market cannot be a price that high.
In contrast, the solid green line is a price ceiling set below the free-market price, called a binding price-ceiling. In this case, the price ceiling has a measurable impact on the market.
A price ceiling set below the free-market price has several effects. Suppliers find they can no longer charge what they had been charging for their products. As a result, some suppliers drop out of the market. This represents a reduction in the quantity supplied. Meanwhile, demanders find that they can now buy the same product at a lower price. As a result, market demand increases as new buyers enter the market and existing buyers consume more of the good.
As a result of these two actions, demand exceeds supply and a shortage ensues. The good must then be rationed by non-market means, such as waiting in line.
Price ceilings are often intended to protect consumers from certain conditions that could make necessities unattainable. But they can also cause problems if they are used for a prolonged period of time without controlled rationing. A good example is rent control in New York City (rent control is a price ceiling on rent). When soldiers were coming back from World War II and starting families (causing a large demand for apartments), but stopped receiving pay (there was no longer a war), many could not deal with the jumping rent. The government put in price controls, so the soldiers and their families were able to pay their rent and keep their homes. However, this increased the demand for apartments and lowered the supply, meaning that all available apartments were rapidly taken, until there were none left for any late-comers.
Producer Surplus is the difference between the price for which a producer would be willing to provide a good or service and the actual price at which the good or service is sold.
Consumer Surplus is the amount that consumers benefit by being able to purchase a product for a price that is less than they would be willing to pay.
Students may often incorrectly attribute a price ceiling as being on top of a supply and demand curve when in fact, an effective price floor is positioned at the top of a supply and demand graph.
[edit] Price floors
A price floor is a government or group imposed limit on how low a price can be charged for a product.[1] For a price floor to be effective, it must be greater than the equilibrium price. In the first graph at right, the supply and demand curves intersect to determine the free-market quantity and price.
A price floor can be set above the free-market equilibrium price. In the second graph at right, the dashed green line represents a price floor set below the free-market price. In this case, the floor has no practical effect. The government has mandated a minimum price, but the market already bears a higher price.
In contrast, the solid green line is a price floor set above the free-market price. In this case, the price floor has a measurable impact on the market.
A price floor set above the market equilibrium price has several side-effects. Consumers find they must now pay a higher price for the same product. As a result, they reduce their purchases or drop out of the market entirely. Meanwhile, suppliers find they are guaranteed a new, higher price than they were charging before. As a result, they increase production.
Taken together, these effects mean there is now an excess supply of the product in the market (third graph). In order to maintain the price floor over the long term, the government must take action to remove that supply.
Price floors set above equilibrium market prices cause surpluses. A historical (and current) example of a price floor are minimum wage laws, laws specifying the lowest wage a company can pay an employee (employees are suppliers of labor and the company is the consumer in this case). When the minimum wage is set higher than the equilibrium market price for unskilled labor, a surplus of labor is created (more people are looking for jobs than can find jobs). A minimum wage above the equilibrium wage would induce employers to hire fewer workers as well as cause more people to enter the labor market. The equilibrium wage for a worker would be dependent upon the worker's skill sets along with market conditions.
[edit] See also
[edit] Sources
Colander, Economics N. Gregory Mankiw, Principles of Economics
[edit] References
- ^ Price floor - Definitions from Dictionary.com. dictionary.reference.com. Retrieved on 2008-05-02.
