4.2.8 Price Ceiling

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From the course by University of Pennsylvania

Microeconomics: The Power of Markets

ratings

University of Pennsylvania

Microeconomics: The Power of Markets

ratings

We make economics decisions every day: what to buy, whether to work or play, what to study. We respond to markets all the time: prices influence our decisions, markets signal where to put effort, they direct firms to produce certain goods over others. Economics is all around us. This course is an introduction to the microeconomic theory of markets: why we have them, how they work, what they accomplish. We will start with the concept of scarcity and how specialization according to comparative advantage helps us achieve more than we could alone. Next we model a marked using the tools of Supply and Demand and learn what well working markets accomplish and what their limit are. We end by exploring the impact of government intervention on perfect markets. Examples are taken from everyday life, from goods and services that we all purchase and use. We will apply the theory to current events and policy debates through weekly exercises. These will empower you to be an educated, critical thinker who can understand, analyze and evaluate market outcomes.

From the lesson

Understanding Markets: Elasticities, Market Surplus, Efficiency, and Equity

There is a lot of terminology this week. We will introduce of the concept of elasticity of demand that measures the responsiveness of quantity demanded to a change in the price of a good. We will explore the relationship between change in price and revenue or sales and how elasticities can help us predict whether a decrease in price will increase or decrease revenue. We then introduce other elasticities of note: cross price elasticity, income elasticity and elasticity of supply. We end the week by exploring the great accomplishment of markets: maximizing the size of the pie or the total benefit to society.

4.2.5 T.S. at a Quantity Greater Than Equilibrium Quantity4:02

4.2.6 T.S. at a Quantity Smaller Than Equilibrium Quantity4:47

4.2.7 Efficiency & Equity: Conclusion1:40

4.2.8 Price Ceiling5:04

4.2.9 Price Floors: The Case of Minimum Wage5:28

4.2.10 Calculating Total Surplus: Numerical Example4:31

4.2.11 Price Ceilings: A Numerical Example5:20

Meet the Instructors

Rebecca Stein
Senior Lecturer
Economics

[MUSIC]

We've seen that market equilibrium maximized total surplus and

of this will be that if we deviate from the market equilibrium.

We will be reducing the total surplus that's generated in the economy.

So if the government intervenes in a competitive market in terms

of trying to change the price or trying to change the quantity, there must be some

negative consequence of this and I'd like to explore this in a couple of segments.

So, one way a government might intervene in the market

is by setting a price ceiling.

In the market for bread, for example,

which is the market that we are going to analyze here.

It might be the case that the government decides that the equilibrium price is

too high, that people can't afford to buy bread when the price is $4 and so

the government might intervene and set what is known as a price ceiling.

I denote this by p with a line on top showing that the price cannot

exceed this price ceiling and for the sake of this example,

let's say that it is a price ceiling of $3.

A price ceiling of $3 means that no one can buy and

no one can sell bread at a price that exceeds $3.

Well, what will happen as a consequence in our market?

At a price of $3,

we can read off the demand curve what will be the quantity demanded.

And we can see that the quantity demanded will be much larger than it was at

a price of $4, because demand is downward sloping and

a lower price encourages more consumers to go out there and look for a loaf of bread.

On the other hand, at this low price of bread of $3,

the quantity supplied is going to be much smaller than the equilibrium quantity.

We can read off the supply curve what would be the quantity supplied and

we find that it's down here.

So in this case, we have excess demand or shortage.

So we have excess demand for bread.

Physically, this will look to us, if we were looking

into this market as a long line of people outside stores.

There'd be a lot of people looking for the bread that wasn't there,

because suppliers could only be prepared to sell the smaller quantity.

If the market was a competitive market, market forces would bring this price

up and we would converge to the equilibrium price of four.

But in this case, market forces aren't working,

because the government is there enforcing this price ceiling.

We assume in our models that the amount that's actually traded in the market is

always the minimum of the quantity demanded and the quantity supplied.

We are not going to force someone to sell when they don't want to sell.

We're not going to force someone to buy when they don't want to buy.

So the amount that's actually traded is the minimum of the two,

it's going to be this quantity here.

As a result, the units that are not traded are all

these units here and these units are all units for

which the marginal benefit exceeds the marginal cost.

In other words, these are units that should be produced,

because these are units that if they were produced would increase total surplus.

By not producing these units, we are cutting off a little bit of the pie.

Instead of total surplus being this whole big triangle here,

it's now just this trapezoid and we've cut off this little bit of a triangle.

We call this piece of total surplus that we've cut off and

thrown away, we call this dead weight

Loss, because this is lost to the total surplus that's generated in

the economy and it's loss that's due to the government intervention.

Again, the metaphor of the hill.

If this equilibrium quantity is the top of the hill, it maximizes the total surplus.

We've moved in this direction, which means we necessarily have moved down the hill.

We've moved from the top downwards.

We've got rid of some of the surplus.

We'd left some of the surplus on the table, we've not generated these units.

And by not generating them, we're creating dead weight loss.

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