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PRICE CEILINGS & PRICE FLOORS (Consumer Surplus & Producer Surplus) Krugman Section 2, Module 8.

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Presentation on theme: "PRICE CEILINGS & PRICE FLOORS (Consumer Surplus & Producer Surplus) Krugman Section 2, Module 8."— Presentation transcript:

1 PRICE CEILINGS & PRICE FLOORS (Consumer Surplus & Producer Surplus) Krugman Section 2, Module 8

2 What you will learn in this Module : The meaning of price controls, one way government intervenes in markets How price controls can create problems and make a market inefficient Why economists are often deeply skeptical of attempts to intervene in markets Who benefits and who loses from price controls, and why they are used despite their well-known problems Module 8

3 What you will learn in this Module : The meaning of quantity controls, another way government intervenes in markets How quantity controls create problems and can make a market inefficient Who benefits and who loses from quantity controls, and why they are used despite their well-known problems Module 9

4 Unpopular market prices Political pressure Why Governments Control Prices Module 8

5 What happens when prices are fixed by the government? Lets look at a graph which shows the average consumption of beer in the United States. Module 8

6 $4 $3 $2 $1 Beers per week S D E GeGe In this example, the average beers consumed per week is 6 at an average price of $2.50.

7 $4 $3 $2 $1 Beers per week S D E This chart illustrates the effects upon people if they were forced to go from G e to zero. GeGe You might be willing to pay $4 for your first beer, but price is $2.50 …..now you are $1.50 better off. This is called CONSUMER SURPLUS.

8 The 9th beer is worth to people what it is worth to people. It is different for everybody.

9 $4 $3 $2 $1 Beers per week S D E GeGe From the suppliers standpoint, they could supply at a lower price but they CAN get more. This is called PRODUCER SURPLUS.

10 $4 $3 $2 $1 Beers per week S D E GeGe The colored area is the total value to society of the cost of 6 beers. Consumer Surplus Producer Surplus

11 $4 $3 $2 $1 Beers per week S D E GeGe Four beers is not enough (too little, inefficient) ….This is called DEADWEIGHT loss. What if government mandate limited the maximum number of beers one could drink to 4 per week? Government Mandated Supply Deadweight loss of gift giving Module 9

12 Quantity Control - Quota Licenses Controlling Quantities Module 9

13 The Anatomy of Quantity Controls Module 9

14 The Anatomy of Quantity Controls Demand Price Supply Price Wedge - Quota Rent Module 9

15 The Cost of Quantity Controls Deadweight Loss Module 9

16 $4 $3 $2 $1 Beers per week S D E GeGe What if government mandate limited the maximum price of a beer to $1.00? Consumers would want to buy more beer. 10 However, suppliers would not want to produce as much beer.

17 $4 $3 $2 $1 Beers per week S D E GeGe If government limited the maximum price of a beer to $1.00, it would create a shortage. If government limited the maximum price of a beer to $1.00, it would create a shortage. shortage Producers will not want to produce for low prices.

18 PRICE CEILING PRICE FLOOR equilibrium. The legal maximum price that can be charged is called a PRICE CEILING. A legal minimum price that can be charged is called a PRICE FLOOR. Price ceilings and floors keep markets from reaching equilibrium.

19 Legal maximum price Examples – Resource prices during WWII – Oil Prices in1970s – California electricity – New York City apartments Price Ceilings

20 Modeling a Price Ceiling Module 8

21 How a Price Ceiling Causes Inefficiency Inefficient Allocation to Consumers Wasted Resources Inefficiently Low Quality Black Markets Module 8

22 So Why Are There Price Ceilings? Benefit some Uncertainty Lack of understanding Module 8

23 Politically popular ideas include: --$ minimums on inputs (wages). --$ maximums on outputs (prices). POLITICS vs. ECONOMICS => Politics always wins When POLITICS vs. ECONOMICS => Politics always wins

24 $4 $3 $2 $1 Beers per week S D E GeGe The government mandating the maximum price of a beer is called a PRICE CEILING. shortage A price ceiling keeps the market from reaching equilibrium.

25 $4 $3 $2 $1 Beers per week S D E GeGe shortage The shortage created from the price ceiling will result in increased demand. X

26 The increased demand and a willingness to pay higher prices will result in a BLACK MARKET for beer.

27

28 $5 $4 $3 $2 $1 Labor S D E GeGe When the government mandates a the minimum price of something, it is called a PRICE FLOOR. The minimum wage is an example of a price floor.

29 $5 $4 $3 $2 $1 Labor S D E GeGe The minimum wage increases the number of people who want to work (supply of labor) And decreases the number of businesses who want to hire (demand for labor) Creating a SURPLUS of labor. SURPLUS

30 A price floor stops the market from reaching equilibrium and creates a surplus. A price ceiling stops the market from reaching equilibrium and creates a shortage. CONCLUSION:

31 Typically, the government jumps in during a surplus, buys the surplus…. and the surplus rots.

32 Legal minimum price Examples – Agricultural products – Minimum wage – Trucking – Air travel Price Floors Module 8

33 Modeling a Price Floor Module 8

34 How a Price Floor Causes Inefficiency Inefficiently Low Quantity Inefficient Allocation of Sales Among Sellers Wasted Resources Inefficiently High Quality Illegal Activity Module 8

35 So Why Are There Price Floors? Benefit some Disregard Lack of understanding Module 8

36

37 PROBLEM SOLVING

38 $5 $4 $3 $2 $1 Beers per week S D E GeGe ANSWER: The 18th Amendment created a shortage of alcohol for consumption When the price of alcohol increased under black market conditions, this initiated the development of the syndicate and the notoriety of such underworld figures as Al Capone.

39 Using economic principles and the impact of government mandate, why was the 18th Amendment to the U.S. Constitution considered the great experiment that failed? QUESTION 1:

40 Using economic principles, explain the impact of government mandates on the supply and demand of the illegal marijuana market. QUESTION 2:

41 $300 $250 $200 $150 $100 $ 50 Marijuana use S D E GeGe ANSWER: In 1937, the government reduced the availability of marijuana to zero by making it illegal. Because people have been willing to pay a high price for the product, black market conditions have existed since the shortage was created. This created a shortage in the market.

42 In 1973, President Nixon froze gasoline prices after the OPEC cartel created a shortage in the United States. What impact did this have on the market economy at that time? QUESTION 3:

43 $4 $3 $2 $1 Gallons of Gas S D E GeGe ANSWER: President Nixon initiated a price ceiling of $1.60. shortage REMEMBER: Producers will not want to produce for low prices. Consequently, a shortage existed because gas companies were taking a loss. This resulted in long lines and gas stations running out of fuel.

44 Using economic principles and the impact of government mandate, explain what would happen if cigarette smoking were made illegal. What would be the opportunity cost of making cigarettes illegal? QUESTION 4:

45 $10 $8 $6 $4 $2 Cigarette use S D E GeGe ANSWER: The government would reduce the supply of cigarettes to zero by making it illegal. Because some people will be willing to pay a high price for the product, black market conditions will exist and the price of cigarettes will increase. This will create a shortage in the market.

46 ANSWER: The opportunity costs would include: Lower environmental costs Cleaner air Lower costs for health care Healthier population Higher unemployment for lost jobs

47 Many experts contend that the Food and Drug Administration (FDA) directly creates the high price of prescription drugs. Do you agree? Why or why not? Explain your answer. Question 5:

48 $100 $80 $60 $40 $20 Drug use S D E GeGe ANSWER: The FDA, a government regulatory agency, reduces the supply of certain drugs by making them unavailable to certain people through the use of prescriptions. Because doctors prescribe drugs for illness and the patient requests good health, they pay the higher price created by the government. This results in a limited market.

49 In May 2001, President Bush visited with Governor Gray of California to discuss the energy crisis in that state. It will take 10 years to build the power plants necessary to provide the electricity needed to support the population and costs will skyrocket as demand exceeds supply. Governor Gray is requesting that President Bush place a federal price ceiling on the cost of energy. Why did President Bush refuse? Question 6:

50 $D $C $B $A Kilowatts 0 a b c d e f g S D E GeGe ANSWER: ANSWER: President Bush realizes that a price ceiling will result in a shortage of electricity. shortage REMEMBER: Producers will not want to produce for low prices. Limiting the price that power companies can charge for electricity will cause them to lose money, not produce efficiently, and result in a shortage of power.

51 THE END Compiled by Virginia Meachum Economics Teacher, Coral Springs High School, Florida Sources: Economics for AP, by Krugman, Wells. Economics, by McConnell, Brue Economics, by Mankiw


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