Econ_100_Ch6-Ch7Part1

Econ_100_Ch6-Ch7Part1 - ECON 100: Introduction to...

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Slide 1 of 25 ECON 100: Introduction to Microeconomic Theory Lecture 8 Yilan Xu
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Slide 2 of 25 Price Ceilings Policy makers may respond to buyers’ complaints that prices are “too high” by enacting price controls. A Price Ceiling is a maximum price allowed by law. § Price ceilings limit the price sellers can charge for their goods to the maximum price. § Prices cannot legally go higher than the ceiling.
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Slide 3 of 25 Price Ceilings Price ceilings that involve a maximum price below the market price create five important effects. 1. Shortages 2. Reduction in Product Quality 3. Wasteful Lines and Other Search Costs 4. Loss of Gains from Trade 5. Misallocation of Resources
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Slide 4 of 25 Shortages 1. When prices are held below the market price shortages emerge where the quantity demanded exceeds the quantity supplied. § The shortage is measured by the difference between the quantity demanded at the controlled price and the quantity supplied at the controlled price. § The lower the controlled price relative to the market equilibrium price, the larger the shortage.
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Slide 5 of 25 Shortages Price Ceilings Create Shortages Quantity Price Supply Demand Market Equilibrium Shortage Controlled Price (Ceiling) Qsupplied at the Controlled Price Qdemanded at the Controlled Price
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Slide 6 of 25 Reduction in Product Quality 2. At the controlled price, sellers have more customers than they have goods. § In a free market, this would be an opportunity to profit by raising prices. § When prices are controlled, however, sellers cannot raise prices without violating the law. § Sellers respond to this problem and increase profits in two ways: Reduce quality Reduce service
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Slide 7 of 25 Wasteful Lines and Other Search Costs 3. Price controls that create shortages lead to bribery and wasteful lines. § Shortages mean that not all buyers will be able to purchase the good. § In free markets buyers compete with other buyers by offering a higher price. § Since price is not allowed to rise above the price ceiling, buyers must compete in other ways.
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Slide 8 of 25 Wasteful Lines and Other Search Costs Some buyers may be willing to bribe sellers in order to obtain the good. § The maximum bribe a buyer would be willing to pay is the difference between the willingness to pay and the controlled price established by the price ceiling. § If bribes are common, then the total price of the good is the legal price plus the bribe.
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Wasteful Lines and Other Search Costs Buyers can also compete with each other through their willingness to wait in line. § The maximum wait time (in monetary terms) for a buyer is the difference between the willingness to pay and the controlled price established by the price ceiling. § Thus, the total price of the good is the legal
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Econ_100_Ch6-Ch7Part1 - ECON 100: Introduction to...

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