Which Of The Following Statements About Price Controls Is True?

Topic 4 Part two: Applications of Supply and Demand

Learning Objectives

By the end of this section, you will be able to:

Explain toll controls, price ceilings, and price floors
Understand why price controls result in deadweight loss

The first government policy nosotros will explore is price controls. In Topic iii, we examined what will occur if price is below or above equilibrium price, and concluded that marketplace pressures volition return the market to equilibrium. But what if the regime regulates the market then that it cannot move?

Price Ceiling

A common example of a price ceiling is the rental market. Consider a rental market with an equilibrium of $600/month. If the government wishes to decrease this cost to brand it more than affordable for renters, it may place a bindingprice ceilingof $400/month. This policy means the landlords cannot charge more than $400 per month. What will this do to our equilibrium? Refer to Figure four.5a. Whereas earlier 300 homes were rented, there is now a housing shortage. At the lower price of $400/calendar month, quantity supplied is only 200 housing units and a quantity demanded is 400 housing units. This means that 200 renters who desire to rent tin can no longer find homes! This is important, because when quantity demanded and quantity supplied are diff,the marketplace is restrained by the lower value.

Despite this information, it is non enough to tell usa if the market is more or less efficient – our metric for that is market place surplus. Even though some renters cannot discover homes, the regime withal successfully lowered the price for some consumers. So how do these furnishings weigh out?

(Credit: Manoel Lemos/ Flickr/ CC BY-SA 2.0)

Relieve Us R2-D2, You're Our Only Hope!

If the equilibrium toll is $6 and the authorities says you cannot accuse more than $8, the government intervention is meaningless or 'non-binding'. Whereas price ceiling aims to lower the toll, cost floors aim to raise it. Since this seems backwards, it is easy to get dislocated about when price ceilings and price floors are bounden. Rather than memorizing which is which, consider an example from Star Wars to aid call back.

In the original Star Wars, Luke, Leia, Han Solo, and Chewbacca are trapped in a garbage disposal that begins to plummet inward. The room becomes more than constrained as the walls come up together. If you were in a room, what would cause you lot to feel constrained? If the ceiling is ascension you have more than space, so it is not constraining. Similarly, if the flooring falls, you have more room. If the ceiling starts falling, or the floor begins to rise so you are constrained. This helps us remember an important principle:

Only a price flooring above equilibrium or a toll ceiling beneath equilibrium is binding.

Computing Market Surplus

To find out the impact of government'due south price ceiling, we must summate marketplace surplus before, and after a policy. This method will be an important guess for all our policy analysis in this topic. Consider Effigy four.5b, where the effects of the Price Ceiling is shown.

Before

The calculation of market surplus before policy intervention should be straight forward past now. Market place surplus is equal to the sum of consumer surplus and producer surplus, calculating from Figure iv.5b:

Consumer Surplus (Blue Surface area): [(1200-600) ten 300]/2 = $90,000

Producer Surplus (Red Expanse): [(600) x 300]/2 = $ninety,000

Market Surplus: $180,000

After

The calculation of marketplace surplus after intervention is less obvious. Consumers have lost surplus in some areas, merely gained surplus in others (we volition await at this closely in the next Figure 4.5c). Producers have lost surplus.

Consumer Surplus (Blue Area): [(1200-800) x 200]/2] + (400×200) = $120,000

Producer Surplus (Cerise Expanse): [(600) x 300]/2 = $40,000

Marketplace Surplus: $160,000

Looking before and afterward nosotros see that producer surplus has decreased and consumer surplus increased – just the decrease in producer surplus outweighed the effects of the increase in consumer surplus, causing deadweight loss.This means that the market is less efficient, because by removing the regulation, the market every bit a whole is better off.

What About Redistribution?

It's easy to look at the full numbers and prove that market place surplus has decreased, but how does this change bear upon individual consumers and firms?

In Effigy iv.5c the areas which alter as a result of the policy are shown.

Consumers

Consumers gain an expanse of A and lose an area of B.

Surplus Subtract – Area B

As mentioned previously, the quantity supplied in the market decreases from 300 rental units to 200. This means that 100 renters tin can no longer find homes. We tin assume that the consumers who are willing to pay most for the homes will finish upwardly with the rental units (they volition start looking before, exploring more options etc.) then consumers on the demand bend WTP between $800 and $600 will be cut out of the marketplace. This results in a $x,000 loss in consumer surplus, shown in Figure iv.5c as surface area B.

Surplus Increase – Surface area A

Alternatively, the 200 consumers who are able to find homes now become from paying $600/month to paying $400/month, resulting in a $forty,000 increase in consumer surplus. This is shown in Effigy iv.5c every bit area A.

Overall, consumers gain $xxx,000, which is consistent with the calculations to a higher place.

Producers:

Producers lose areas C and A

Surplus Decrease – Surface area C

The toll ceiling causes the landlords to reconsider staying in the rental marketplace, as fewer landlords tin brand a profit with the lower cost. This causes 100 landlords to leave the market, reducing their producer surplus to zilch. This forgone surplus amounts to $10,000 and is represented in Figure 4.5c as surface area C.

Surplus Subtract – Surface area A

Like consumers, some producers will remain in the market, simply these producers now take to face up the reality of lower hire revenue. Each of the 200 landlords loses $200 of revenue. This results in a $twoscore,000 decrease, represented every bit area A.

Overall, producers lose $50,000, which is consistent with the calculations in a higher place.

Transfer and Deadweight Loss:

dWe tin summarize the overall effects in the marketplace as two categories: a transfer of surplus and a deadweight loss.

Transfer

Discover that Area A was a transfer from the landlords to the renters who remain in the market. 200 renters now save $200 each, and 200 landlords at present lose $200 each. Information technology is important to recognize that this transfer is a result of theprice effectof the policy, pregnant information technology occurred considering price differed from equilibrium.

DWL

Alternatively, the deadweight loss results considering in that location are players who are no longer able to exist a role of the market. 100 renters and 100 landlords all lose a varied amount based on their willingness to pay and marginal costs. This change is a upshot of thequantity effecton the policy, meaning it occurred because quantity differed from equilibrium.

A change in quantity from the equilibrium value is the but matter that causes a DWL. Changes in price will crusade transfers. While the two effects work together, information technology is of import to be able to distinguish betwixt the two.

This was a fairly lengthy explanation of toll ceilings, but it is one that will lead into the discussion of all policy. Every policy we volition await at in microeconomics has both a quantity effect and a price effect, and it is important to understand how the policy impacts individual market players.

Price Floor

While the price floor has a very similar analysis to the price ceiling, it is important to look at it separately. A mutual instance of a price floor is a minimum wage policy. The labor market place is unique in that the workers are the producers of labor and the firms are consumers of labor. Toll can exist denominated in hourly wage, with the quantity of workers on the x-axis. If the government sets a binding minimum wage (price floor), it must be fix above the equilibrium toll.

In Figure 4.5d, the equilibrium wage is shown as $ten/hour. This is where the demand for labor is equal to the number of workers who want to detect jobs. At this level at that place is no unemployment. All the same, if the government sets a minimum wage of $13/hour, this will alter. The Quantity of Labor Supplied (workers looking for jobs) will be 400, but the quantity demanded will exist 200. This means that 200 workers volition be unemployed! Again, this is not enough information to determine whether the market place is inefficient – nosotros accept to summate the change in market surplus!

labour-market-price-floor-surplus — Effigy iv.5e

Using the same procedure as before:

Before

Consumer Surplus (Blueish Area): [(20-10) ten 300]/2 = $1500

Producer Surplus (Red Area): [(10) 10 300]/ii = $1500

Market Surplus: $3000

After

Consumer Surplus (Blue Surface area): [(20-xiii) x 200]/ii= $700

Producer Surplus (Red Expanse): [(13-seven) ten 200] + (7 x 200)/ii = $1900

Market Surplus: $2600

Since the market place surplus after the policy is less than the market surplus before, in that location is a deadweight loss!

Once again, the changes in the market tin be categorized as a transfer and a deadweight loss. This fourth dimension, the transfer is from consumers (firms) to producers (workers), since the workers who are able to find piece of work are better off. This causes no modify to market place surplus in isolation but is coupled with the deadweight loss caused by workers who are no longer able to find jobs equally firms leave the market.

Summary

In the absence of externalities, both the toll floor and price ceiling crusade deadweight loss, since they change the market place quantity from what would occur in equilibrium. This is accompanied by a transfer of surplus from one player to some other. If the goal of the policy is to reduce quantity to a certain level, both a toll ceiling or a price floor could be used to achieve this aim. In this example, both policies would result in the same size DWL. The distribution of surplus will be very unlike, merely the change in quantity away from equilibrium is the but variable that matters when calculating DWL. As we will encounter, if a tax, quota, or any other policy causes the same change in quantity as another, the deadweight loss will be the aforementioned.

Glossary

Toll Ceiling: a legal maximum price

Toll Control: government laws to regulate prices instead of letting market place forces determine prices


Price Effect: the impact when price differs from equilibrium, causes a transfer of surplus between parties


Price Flooring: a legal minimum price


Quantity Outcome: the impact when quantity differs from equilibrium, causes a deadweight loss to society

Exercises 4.v

The following Ii questions refer to the supply and demand curves illustrated below.

i. A price ceiling of P3 causes:

a) A deadweight loss triangle whose corners are ABC.
b) A deadweight loss triangle whose corners are ACD.
c) A deadweight loss triangle whose corners are BEC.
d) A deadweight loss triangle whose corners are CDE.

2. A toll flooring of P1 causes:

a) Backlog need equal to the distance AB.
b) Excess supply equal to the altitude AB.
c) Backlog supply equal to the altitude DE.
d) Excess need equal to the distance DE.

3. Which of the following statements most price ceilings is TRUE? (Presume the price ceiling is fix beneath the unregulated equilibrium price.)

a) Cost ceilings make sellers worse off.
b) Toll ceilings brand buyers better off.
c) Both a) and b) are true.
d) Neither a) nor b is truthful).

4. Which of the following statements nigh minimum wages is true?

a) Minimum wage laws may make some workers better off and others worse off.
b) Minimum wage laws brand employers worse off.
c) Both a) and b) are true.
d) None of the above are truthful.

v. Consider diagram below, which illustrates the market place for low-skilled labour.

Suppose that the equilibrium quantity is reduced from Q1 to Q2 units, through the introduction of a toll flooring. Which of the following correctly describes the resulting subtract in MARKET surplus?

a) Market place surplus will subtract by a – c.
b) Market place surplus will subtract by past east + c.
c) Market surplus will subtract by a + b + e + c.
d) Market surplus will decrease by b – east.

6. Consider diagram below, which illustrates the market for low-skilled labour.

If the government introduces a minimum wage law set at $9 per hour, then, in the new equilibrium, which of the post-obit statements is True?

I. There will be 11,000 workers willing to work who cannot find piece of work, given the wage.
Ii. The number of workers employed will subtract by eleven,000.
III. The number of workers that employers are prepared to hire will decrease by 5,000.

a) I simply.
b) I and II only.
c) I, 2, and Three.
d) I and Iii only.

7. Suppose that the BC government wishes to reduce the quantity of beer sold in the Province past 20%. Information technology has calculated that this goal can be achieved EITHER through a price flooring set at $2 per 6-pack of beer OR a price ceiling of $20 per half dozen-pack of beer. Assume that the electric current price of beer is $10 per six-pack. Which of the following statements about these policies is True?

a) The deadweight loss from the price floor will be greater than the deadweight loss from the price ceiling.
b) The deadweight loss from the price ceiling will be greater than the deadweight loss from the price floor.
c) There is insufficient information to make up one's mind which policy volition have the large deadweight loss.
d) None of the in a higher place statements is true.

viii. Consider the supply and need diagram below. Assume no externalities.

If a price floor of $twenty is introduced, and then which area will represent the deadweight loss?

a) eastward.
b) e + d.
c) due east + b + d.
d) The deadweight loss will exist zippo.

ix. If a cost ceiling (set below the initial equilibrium price) is introduced in a market, so:

a) Producer surplus definitely decreases.
b) Consumer surplus definitely increases.
c) Neither a) nor b) are true.
d) Both a) and b) are true.

ten. In Canada, the prices of almost medical services are regulated past the Provinces (that is, they are subject to price ceilings). This blazon of regulation is likely to result in which of the following (relative to an unregulated market place)?

a) An increment in the quantity of medical services provided.
b) Consumption of medical services such that the marginal benefit is less than the marginal cost.
c) Lower incomes for providers of medical services.
d) College tax revenues for Provincial governments.