Government Intervention - Week 5.docx - Economics – Week 5 Chapter 5 Government Intervention The Cost of Interfering with Market Forces Price Ceiling

Government Intervention - Week 5.docx - Economics – Week...

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Economics – Week 5 Chapter 5: Government Intervention The Cost of Interfering with Market Forces Price Ceiling Definition: - A price ceiling is a maximum allowable price imposed by the government. o Need to set price ceiling below the market price in order to have an effect o When price is lowered, fewer producers are willing to produce and so the quantity supplied goes down. When this happens, the surplus is transferred from the producers to the consumers. o Deadweight loss = lost surplus when the price is lowered. - Rationing rule dictates that the buyers who value a good more will be the first to buy it. Government intervention tends to create winners and losers. - Winners: the consumers who get to purchase the good. - Losers: the producers and the consumers who would have purchased the good but now cannot. The market price with the price ceiling is therefore not Pareto efficient. Letting a producer sell to one more buyer at a higher price would be a Pareto improving transaction. - Deadweight loss is the loss in economic surplus due to the market being prevented from reaching the equilibrium price and quantity where marginal benefit equals marginal cost. - DWL (deadweight loss) > 0 means losers could compensate winners to under the policy. - Deadweight loss exists because there is a beneficial trade that could occur (between the first consumer and producer after the imposed price, where the MB is still > MC for the consumer and RP>MC), but cannot because of government policy. Therefore, price ceilings are usually imposed by government for poorer people for some essential items. Price Floor Definition: - A price floor is a minimum allowable price imposed by the government. - Price floor is only effective if we set it above the market equilibrium price. - Benefit the producers by raising the price - In markets where we want to protect the income of producers.
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  • Two '13
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