lecture notes - Chapter 5 Price Controls and Quotas Meddling with Markets I Price Controls A Definition A price control is a legal restriction on how

lecture notes - Chapter 5 Price Controls and Quotas...

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Chapter 5: Price Controls and Quotas: Meddling with MarketsI. Price ControlsA. Definition: A price control is a legal restriction on how high or low a market price may go.B. Price controls are enacted by governments in response to political pressures from buyers and sellers.II. Price CeilingsA. Definition: A price ceiling is a maximum price sellers are allowed to charge for a good.B. Modeling a price ceiling: A price ceiling is set below the equilibrium price. A price ceiling set above the equilibrium price has no effect. Figure 5-2.C. A price ceiling set below the equilibrium price creates a shortage.The Effects of a Price CeilingD. A price ceiling causes inefficiency.1. Definition: Deadweight loss is the loss in total surplus that occurs whenever an action or a policy reduces the quantity transacted below the efficient market equilibrium quantity.2. Definition: Inefficient allocation to consumers: People who want the good badly and are willing to pay a high price don’t get it, and those who care relatively little about the good and are only willing to pay a low price do get it.3. Definition: Wasted resources: People spend money and expend effort in order to deal with the shortages caused by the price ceiling.4. Definition: Inefficiently low quality: Sellers offer low-quality goods at a low price even though buyers would prefer a higher quality at a higher price.E. Price ceilings lead to black markets.1. Definition: A black market is a market in which goods or services are bought and sold illegally—either because it is illegal to sell them at all or because the prices charged are legally prohibited by a price ceiling.F. Price ceilings are enacted because1. They do benefit some people.2. When they have been in effect for a long time, buyers may not have a realistic idea of what would happen without them.3. Government officials often do not understand supply and demand analysis.III. Price FloorsA. Definition: A price floor is a minimum price buyers are required to pay for a good.B. Definition: The minimum wage is a legal floor on the wage rate, which is the market price of labor.C. Price floors lead to excess supply; the quantity supplied is greater than quantity demanded at the set price. Price floors are ineffective if set below the equilibrium price.D. Modeling a price floor: A price floor is set at a price that is above the equilibrium price. Figure 5-6.The Effects of a Price FloorE. A price floor causes inefficiency.1. Inefficiently low quantity: Since a price floor raises the price of a good to consumers, quantity demanded falls, so the quantity bought and sold falls, creating deadweight loss.2. Definition: Inefficient allocation of sales among sellers: Those who would be willing to sell the goodat the lowest price are not always those who actually manage to sell it.
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