[MUSIC] As we will learn in several future lessons, it's not uncommon for the government to intervene into the free market for any number of purposes. Sometimes such intervention is to correct what the government perceives to be a market failure, with the goal of making the market more efficient. At other times, the government may intervene simply to redistribute income from one group to another. Often with an improvement in equity within the society, but often with a loss in market efficiency as well. To better understand the market consequences of such government intervention, let's use our supply and demand framework to examine two common forms of government intervention, the price floor and the price ceiling. So here's two key definitions. A price floor sets a minimum price for a product that may well be at a level above that of the market equilibrium [MUSIC] In contrast, a price ceiling may be set at a level well below what would be the actual price at market equilibrium. Now think about this for a moment, which type of government intervention is likely to lead to shortages in the market and which is likely to lead to surplus? [MUSIC] Let's answer that question by doing our own market analyses. And let's start with the case of a price floor. In fact, this tool is frequently used in many other countries around the world, particularly in the farming sector. Such so-called price support programs are used for products ranging from milk, corn, and wheat, to peanuts and sugar. And they typically set a price floor for the farmers' commodities and crops. Typically, if the market price falls below this floor, the government then makes up the difference to the farmer. In essence, by buying up any of the farmer's surpluses. This figure illustrates such a price floor for milk. As with all of our graphs, price is on the vertical axis and quantity is on the horizontal axis. Note that the market price is at P1. But the price floor has been set well above that at P 2. So what's the surplus equal to in this case? [MUSIC] That's right, the surplus is equal to Q3 minus Q1. Okay, now let's do the case of a price ceiling. And let's use a pretty interesting historical example. In particular, during World War II, the American government instituted price control on most consumer goods including many types of food. This figure shows what happened in the market for bread during the war. You can see that the market price would normally be at P1 at point A where the supply and demand curves cross. However, after the government set a price ceiling at P2, well bellow the market equilibrium, this created a shortage in the market equal to the difference between Q3 and Q1. And by the way, the tool that the government used to manage this shortage was to create a system of what is called rationing. In this particular rationing system, consumers couldn't go to the store and just pay for a loaf of bread. They also had to present a ration card that gave them the right to purchase the bread. In this way, the government replaced the market as the mechanism to answer the for whom question as to who got the bread. So during the war, poor people had as much access to bread as rich people. Of course, that all sounds pretty fair but in this kind of situation, one likely outcome is the rise of the so-called black market in which entrepreneurial people resell their products to make a profit in an underground economy far from the prying eyes of the government. The broader point here is that once you interfere with the market mechanism, all sorts of things can happen. Shortages, surpluses, black markets, and so on. That's one reason why many societies prefer to rely primarily on the market system. [MUSIC]
