© 2005 Thomson C hapter 6 Price Ceilings and Price Floors

© 2005 Thomson 2 Gottheil - Principles of Economics, 4e Economic Principles Government intervention in markets Price ceilings Price floors Parity pricing Target prices Crop limitation programs

© 2005 Thomson 3 EXHIBIT 1PRODUCTION POSSIBILITIES CURVE FOR CIVILIAN AND DEFENSE GOODS

© 2005 Thomson 4 Gottheil - Principles of Economics, 4e Exhibit 1: Production Possibilities Curve for Civilian and Defense Goods The production possibilities curve in Exhibit 1 provides information on: The production possibilities curve shows the possible combination of civilian and defense goods that could be produced.

© 2005 Thomson 5 Gottheil - Principles of Economics, 4e Exhibit 1: Production Possibilities Curve for Civilian and Defense Goods When there is a national security crisis, the number of civilian goods produced: The production of civilian goods declines as more defense goods are produced.

© 2005 Thomson 6 EXHIBIT 2THE FISH MARKET BEFORE AND AFTER THE DRAFT

© 2005 Thomson 7 Gottheil - Principles of Economics, 4e Exhibit 2: The Market Before and After the Draft In Exhibit 2, the communitys predraft and postdraft demand for fish does not change. Demand for fish doesnt change just because theres a national security problem.

© 2005 Thomson 8 Gottheil - Principles of Economics, 4e Exhibit 2: The Market Before and After the Draft In Exhibit 2, the communitys predraft and postdraft demand for fish does not change. Note that the demand curves before and after the supply curve has shifted are identical.

© 2005 Thomson 9 Gottheil - Principles of Economics, 4e Exhibit 2: The Market Before and After the Draft After the draft, the quantity of fish supplied: With fishermen being drafted and fewer boats in the water, the supply of fish declines and the supply curve shifts to the left.

© 2005 Thomson 10 Gottheil - Principles of Economics, 4e Exhibit 2: The Market Before and After the Draft Postdraft, the equilibrium price of fish: The equilibrium price of fish increases from $4 to $10 after the draft.

© 2005 Thomson 11 Gottheil - Principles of Economics, 4e Exhibit 2: The Market Before and After the Draft After the draft, the quantity of fish bought and sold: The quantity of fish bought and sold declines from 10,000 to 7,000 fish.

© 2005 Thomson 12 Gottheil - Principles of Economics, 4e Exhibit 2: The Market Before and After the Draft The greater burden of the increased price for fish is felt by: The poor The rich

© 2005 Thomson 13 Gottheil - Principles of Economics, 4e Exhibit 2: The Market Before and After the Draft The greater burden of the increased price for fish is felt by: The poor The rich

© 2005 Thomson 14 Gottheil - Principles of Economics, 4e Exhibit 2: The Market Before and After the Draft The greater burden of the increased price for fish is felt by: The increase in the price of fish makes it unthinkable for the poor to purchase fish, while the rich hardly notice the increase and continue to buy fish.

© 2005 Thomson 15 Gottheil - Principles of Economics, 4e Price Ceiling Price ceiling A maximum price set by government below the market-generated equilibrium price.

© 2005 Thomson 16 EXHIBIT 3SETTING A $4 PRICE CEILING IN THE FISH MARKET

© 2005 Thomson 17 Gottheil - Principles of Economics, 4e Exhibit 3: Setting a $4 Price Ceiling in the Fish Market In Exhibit 3, when a $4 price ceiling is set, the market for fish: When the price ceiling is set at $4, the quantity of fish demanded increases from 7,000 to 10,000.

© 2005 Thomson 18 Gottheil - Principles of Economics, 4e Exhibit 3: Setting a $4 Price Ceiling in the Fish Market In Exhibit 3, when a $4 price ceiling is set, the market for fish: Based on the post-draft supply curve, the quantity of fish supplied falls from 7,000 to 4,000.

© 2005 Thomson 19 Gottheil - Principles of Economics, 4e Exhibit 3: Setting a $4 Price Ceiling in the Fish Market In Exhibit 3, when a $4 price ceiling is set, the market for fish: Based on the postdraft supply curve, there is a shortagean unsatisfied excess demandof 6,000 fish.

© 2005 Thomson 20 Gottheil - Principles of Economics, 4e Exhibit 3: Setting a $4 Price Ceiling in the Fish Market Allocate a shortage of goods: One method is through the use of ration coupons.

© 2005 Thomson 21 Gottheil - Principles of Economics, 4e Exhibit 3: Setting a $4 Price Ceiling in the Fish Market Allocate a shortage of goods: Ration coupons are issued by the government, entitling the holder to purchase a specific quantity of a good at or below the price ceiling.

© 2005 Thomson 22 Gottheil - Principles of Economics, 4e Exhibit 3: Setting a $4 Price Ceiling in the Fish Market Allocate a shortage of goods: Ration coupons may be issued based on schemes such as: First come, first served. Lottery. Household size.

© 2005 Thomson 23 Gottheil - Principles of Economics, 4e Price Ceiling and Housing Rent control is a government-set price ceiling on rent.

© 2005 Thomson 24 Gottheil - Principles of Economics, 4e Price Ceiling and Housing Arguments against rent control: It dampens landlords incentives to properly maintain their existing rental units. It discourages many people from investing in new construction.

© 2005 Thomson 25 Gottheil - Principles of Economics, 4e Price Floors Price floor A minimum price set by government above the market-generated equilibrium price.

© 2005 Thomson 26 EXHIBIT 4EFFECT OF NEW TECHNOLOGY ON THE FISH MARKET

© 2005 Thomson 27 Gottheil - Principles of Economics, 4e Exhibit 4: Effect of New Technology on the Fish Market When a new technology is adopted, the supply curve in the fish market: The supply curve shifts the the right.

© 2005 Thomson 28 Gottheil - Principles of Economics, 4e Exhibit 4: Effect of New Technology on the Fish Market After adopting the new technology, total revenue for the fisherman: Total revenue decreases.

© 2005 Thomson 29 Gottheil - Principles of Economics, 4e Exhibit 4: Effect of New Technology on the Fish Market After adopting the new technology, total revenue for the fisherman: Prior to adopting the new technology, 10,000 fish were sold at an equilibrium price of $4 each, for a total revenue of $40,000.

© 2005 Thomson 30 Gottheil - Principles of Economics, 4e Exhibit 4: Effect of New Technology on the Fish Market After adopting the new technology, total revenue for the fisherman: After adopting the new technology, 12,000 fish are sold at an equilibrium price of $2 each, for a total revenue of $24,000.

© 2005 Thomson 31 EXHIBIT 5SETTING A $4 PRICE FLOOR IN THE FISH MARKET

© 2005 Thomson 32 Gottheil - Principles of Economics, 4e Exhibit 5: Setting a $4 Price Floor in the Fish Market In Exhibit 5, when a $4 price floor is set, the market for fish: The quantity of fish supplied increases from 12,000 to 15,000. The quantity of fish demanded declines from 12,000 to 10,000. A surplus, or excess supply, of 5,000 fish is created.

© 2005 Thomson 33 Gottheil - Principles of Economics, 4e Exhibit 5: Setting a $4 Price Floor in the Fish Market The excess supply of fish can be dealt with: The decision to support a price floor is a societal matter. If the community represented by the government wants to support the fishermen through a price floor, then the government will buy the excess supply.

© 2005 Thomson 34 EXHIBIT 6GROWTH OF U.S. AGRICULTURAL PRODUCTIVITY THROUGHOUT U.S. HISTORY * Precise data are not available. Source: James Zelner and R.M. Lamm, Agricultures Vital Role for Us All, FoodFrom Farm to Table, 1982 Yearbook of Agriculture, Department of Agriculture, Washington, D.C., p. 3.

© 2005 Thomson 35 Gottheil - Principles of Economics, 4e Exhibit 6: Growth of US Agricultural Productivity Throughout U.S. History Agricultural productivity has increased in the U.S. because: Changes in the dominant energy source technology used on farms.

© 2005 Thomson 36 Gottheil - Principles of Economics, 4e Exhibit 6: Growth of US Agricultural Productivity Throughout U.S. History Agricultural productivity has increased in the US because: Advances in modern chemistry to produce fertilizers, insecticides, crop ripeners and food preservatives.

© 2005 Thomson 37 Gottheil - Principles of Economics, 4e EXHIBIT 7NUMBER AND SIZE OF U.S. FARMS Source: Public Policy and the Changing Structure of American Agriculture, Congressional Budge Office, The Congress of the United States, Washington, D.C., September 1978, p. 2; Agricultural Statistics, 1995–1996, United States Department of Agriculture, Washington, D.C., 1996.

© 2005 Thomson 38 Gottheil - Principles of Economics, 4e Exhibit 7: Number and Size of U.S. Farms Since 1945, the average size of U.S. farms: The average size of US farms has steadily increased, from 195 acres in 1945 to 496 acres in 1995.

© 2005 Thomson 39 Gottheil - Principles of Economics, 4e Exhibit 7: Number and Size of U.S. Farms The number of farms in the U.S.: The number of farms has declined from about 6 million in 1945 to about 2 million by 1995.

© 2005 Thomson 40 Gottheil - Principles of Economics, 4e EXHIBIT 8INDEXES OF TOTAL FARM OUTPUT: 1950–99 (1996 = 100) Source: Economic Report of the President, 2003, Washington, D.C., p. 439.

© 2005 Thomson 41 Gottheil - Principles of Economics, 4e Exhibit 8: Indexes of Total Farm Output: (1996 = 100) Total farm output in the U.S. between 1950 and 1999 almost: Fell by one-half Doubled Tripled

© 2005 Thomson 42 Gottheil - Principles of Economics, 4e Exhibit 8: Indexes of Total Farm Output: (1996 = 100) Total farm output in the U.S. between 1950 and 1999 almost: Fell by one-half Doubled Tripled

© 2005 Thomson 43 EXHIBIT 9EFFECT OF NEW TECHNOLOGY IN FARMING

© 2005 Thomson 44 Gottheil - Principles of Economics, 4e Exhibit 9: Effect of New Technology in Farming As new energy source technologies and modern chemistry increase productivity and shift the supply curve to the right, price: Price declines with each shift of the supply curve to the right.

© 2005 Thomson 45 Gottheil - Principles of Economics, 4e Parity pricing Parity pricing describes one criteria used to determine the level at which a price floor should be set. Parity Pricing

© 2005 Thomson 46 Gottheil - Principles of Economics, 4e It asks for equality between the prices that farmers have to pay for the goods they buy, and the prices they get for the goods they sell. Parity pricing Parity Pricing

© 2005 Thomson 47 Gottheil - Principles of Economics, 4e Parity Pricing Parity pricing was adopted by the government in 1933 when Congress passed the Agricultural Adjustment Act. Parity pricing

© 2005 Thomson 48 EXHIBIT 10 SHOES AND CORN: SHIFTS IN DEMAND AND SUPPLY: 1914–2000

© 2005 Thomson 49 Gottheil - Principles of Economics, 4e Exhibit 10: Shoes and Corn: Shifts in Demand and Supply: In Exhibit 10, the market for shoes changes from 1914 to 1964: While the supply curve for shoes remained unchanged, the demand curve for shoes shifted to the right.

© 2005 Thomson 50 Gottheil - Principles of Economics, 4e Exhibit 10: Shoes and Corn: Shifts in Demand and Supply: In Exhibit 10, the market for shoes changes from 1914 to 1964: The shift in demand raised the equilibrium price for shoes from $2 to $4.

© 2005 Thomson 51 Gottheil - Principles of Economics, 4e Exhibit 10: Shoes and Corn: Shifts in Demand and Supply: The market for corn changed in the same time period: The demand curve for corn remained unchanged, while breakthroughs in technology and chemicals shifted the supply curve for corn to the right.

© 2005 Thomson 52 Gottheil - Principles of Economics, 4e Exhibit 10: Shoes and Corn: Shifts in Demand and Supply: The market for corn changed in the same time period: The equilibrium price of corn declined from $2 in 1914 to $1 in 1964.

© 2005 Thomson 53 Gottheil - Principles of Economics, 4e Exhibit 10: Shoes and Corn: Shifts in Demand and Supply: Parity pricing affects the quantity of corn demanded and supplied: Parity pricing, setting a price floor of $4 for corn, restores the exchange parity between corn and shoes.

© 2005 Thomson 54 Gottheil - Principles of Economics, 4e Exhibit 10: Shoes and Corn: Shifts in Demand and Supply: Parity pricing affects the quantity of corn demanded and supplied: It also creates an excess supply of 50 million bushels of corn.

© 2005 Thomson 55 Gottheil - Principles of Economics, 4e Parity Price Ratio Parity price ratio The relationship between prices received by farmers and prices paid by farmers.

© 2005 Thomson 56 EXHIBIT 11PARITY PRICE RATIOS OF PRICES RECEIVED AND PAID BY FARMERS: 1910–2000

© 2005 Thomson 57 Gottheil - Principles of Economics, 4e Exhibit 11: Parity Price Ratios of Prices Received by Farmers and Paid by Farmers: Changes in the parity price ratio since 1910: Except for the period between 1910 and 1920 and during the 1940s, the parity price ratio has been on the decline.

© 2005 Thomson 58 Gottheil - Principles of Economics, 4e Commodity Credit Corporation The Commodity Credit Corporation (CCC) The CCC is the federal agency established by the Agricultural Adjustment Act of 1933 to absorb the excess farm supply created by parity pricing.

© 2005 Thomson 59 Gottheil - Principles of Economics, 4e Commodity Credit Corporations Loans: Public Law 480 In 1954 Congress enacted the Food for Peace law: Designed to help U.S. farmers, its impact on Third World countries has been the difference between survival and national disaster.

© 2005 Thomson 60 Gottheil - Principles of Economics, 4e Target Price Target price A minimum price level for specific farm goods that the government sets and guarantees.

© 2005 Thomson 61 Gottheil - Principles of Economics, 4e Target Price Target price A deficiency payment is a government payment to farmers based on the difference between the target price set by government and the market price.

© 2005 Thomson 62 Gottheil - Principles of Economics, 4e Target Price Target price Congress moved from parity pricing to setting target prices in 1973 with the passage of the Agricultural and Consumer Protection Act.

© 2005 Thomson 63 EXHIBIT 12COMPARING THE OUTCOMES OF PARITY AND TARGET PRICING

© 2005 Thomson 64 Gottheil - Principles of Economics, 4e Exhibit 12: Comparing the Outcomes of Parity and Target Pricing Government expenditures on corn differ between the parity system and the target system: With parity pricing, the government absorbs the excess corn supply: Of 50 million bushels. At a subsidy price of $4 per bushel. A total subsidy of $200 million.

© 2005 Thomson 65 Gottheil - Principles of Economics, 4e Exhibit 13: Comparing the Outcomes of Parity and Target Pricing Government expenditures on corn differ between the parity system and the target system: With target pricing: Government guarantees farmers $4 per bushel. Consumers purchase all 135 million bushels at the equilibrium price of $1 per bushel. Government must make up the difference of $3 per bushel for a total of $405 million.

© 2005 Thomson 66 Gottheil - Principles of Economics, 4e Exhibit 13: Comparing the Outcomes of Parity and Target Pricing The crop restriction in target pricing affects the deficiency payment: The crop restriction limits the number of acres a farmer can plant. Reducing the quantity of corn supplied from 135 million to 100 million bushels.

© 2005 Thomson 67 Gottheil - Principles of Economics, 4e Exhibit 13: Comparing the Outcomes of Parity and Target Pricing The crop restriction in target pricing affects the deficiency payment: Consumers pay the new equilibrium price of $3 per bushel. Government pays the $1 per bushel deficiency payment. The total payment is $100 million.