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1 Price ceiling This is an example of government intervention in a market.

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Presentation on theme: "1 Price ceiling This is an example of government intervention in a market."— Presentation transcript:

1 1 Price ceiling This is an example of government intervention in a market.

2 2 D P Q P1 Q1 The height of the demand curve at any quantity is the most anyone would pay for that unit. We can call it the reservation price – it is the highest price that could occur for the unit and have someone still call in a reservation to get the unit. In this graph at Q1 we see P1 is the most someone is willing to pay for this unit. On all the units before Q1, some consumers are willing to pay even more than P1. Units after Q1 are not demanded when the price is P1 because consumers are not willing to pay P1 for those units. On the last unit, Q1, sometimes called the marginal unit, the price P1 is the value on the last unit. Thus with a price of P1, all units of equal or greater value are demanded.

3 3 P Q P1 Q1 The height of the supply curve at any quantity is the least any supplier would take for that unit. We can call it the reservation price. In this graph at Q1 we see P1 is the least someone is willing to accept for this unit. On all the units before Q1, some sellers are willing to receive less than P1. Units after Q1 are not supplied when the price is P1 because sellers need more then P1 for those units. On the last unit, Q1, sometimes called the marginal unit, the price P1 is the value on the last unit. Thus with a price of P1, all units of equal or lower value are supplied.

4 4 price ceiling P S1 D1 Q Q1 P1 A price ceiling is a maximum legal price. The government enacts one when it is felt the market price is too high. So an effective legal maximum must be below the equilibrium price. Price can then not legally get to P1. Pc Qs Qd The upward arrow is here to suggest price can not get above Pc.

5 5 price ceiling With the price ceiling we see: 1) lower price Pc, 2) lower quantity supplied - from Q1 to Qs. This is really also the amount traded. The amount traded has fallen because buyers can only buy what sellers sell. 3) Higher quantity demanded - Q1 to Qd. 4) shortage = Qd - Qs.

6 6 price ceiling P S1 D1 Q Q1 P1 Note again that the amount traded will be Qs. And the price ceiling is Pc, so this is the price charged in the market. Pc Qs Qd Pw

7 7 Note on the previous graph I have a solid vertical line above the quantity 1 unit higher than Qs. Note the height of the demand curve here. This is what some demander is willing to pay for this unit. The height of the supply curve is what some seller is willing to receive on this unit. As an example, say someone is willing to pay 10 for the unit and a seller is willing to accept about Can both the buyer and the seller of this unit benefit? Sure – like say they trade the unit for 5. Each benefits and you see the surplus of each is 5 and 1.50, respectively. Are any of the folks involved in the Qs units traded made worse off by allowing this extra unit to be traded? No, maybe they could be better off, but they are not worse off.

8 8 Efficient A situation is efficient if no change is possible that will help some people without harming others. I add this: If Price and quantity take anything other than their equilibrium values, a transaction that will make at least some people better off without harming others can always be found. So, price ceilings are inefficient. A change is possible that will help some without harming others. There is another problem with a price ceiling

9 9 price ceiling P S1 D1 Q Q1 P1 This screen is a repo of a previous screen. Imagine you are sitting at P1, do it! Where do you look for the ceiling? Down! Why not up? A ceiling above P1 would cause a surplus and we know with a surplus the price will fall. It would fall to P1. Pc Qs Qd The upward arrow is here to suggest price can not get above Pc. Price ceilings above equilibrium are not binding Or are not effective! P S1 D1 Q1 P1 Pc Qs Qd

10 10 Vertical Supply D S P Q P1 Pc Q1 Qd

11 11 Vertical Supply Many times after a sports team issues tickets to a game a market develops for tickets to the game. Suppliers in this market actually already have a ticket, but may sell it. The supply in this case is a vertical line at the amount of tickets folks are willing to part with – we note the price could be almost any level, but now higher prices do not elicit a higher quantity supplied. Supply is fixed at the capacity of folks willing to give up tickets. On the previous slide with the supply we see the demand would lead to a market price of P1. Many places say you can not scalp a ticket for more than the price on the ticket.

12 12 Vertical supply If the price on the ticket is an effective ceiling then we have some situations created. 1) An excess demand for tickets is created. This means more people want tickets than there are tickets available. Qd minus Q1 represents the demand from people who value tickets less than P1 in price. In fact, the closer we get to Q1 the less people value the ticket because they are only willing to pay a lower price to get the ticket. Qd minus 0 represents the demand from people who even value the ticket more than P1. If anyone up to Q1 units offers Pc the seller would take it. But the seller doesnt know if the person buying the ticket values it more than PC. It is possible that tickets do not go to those who value the ticket most.

13 13 Vertical supply 2) Mutually beneficial trade may be eliminated. Many folks are willing to pay more than Pc for the ticket and the seller may value the ticket at most Pc. Say a buyer is willing to pay 100 for the ticket and the seller values the ticket at 15. If the two negotiate a price of 70 the buyer gets the ticket for 30 less than they value it and the seller gets 55 more than it is worth to them. But, if the trade can be no higher than 15 then maybe the trade doesnt occur. Here is the last point – to overcome this last point maybe the seller says you can have the ticket if you give me 15 (the ceiling) plus you give me 55 for a pencil. The buyer is still happier by 30 and the seller is happier by 55.


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