Here are two examples of government intervention in a market. Price Supports Here are two examples of government intervention in a market.

Word association game I’ll say a word and I want you to look at the word I say. You better play because I’ll know if you don’t. Left hand Ceiling Right foot Floor. Very good class! Now, in economics when we say ceiling and floor we want you to think differently.

Price Ceilings and Price Floors Price ceilings and price floor are government price “supports” that occur mainly because folks have indicated there is something about the market price that they do not care for. Typically this dislike is that the price is too high or too low. When you walk in a room you stand with the floor below and the ceiling up. BUT, when you stand at the market price the floor has to be above and the ceiling below. Let’s see why.

price floor The downward arrow is here to suggest price can not get below Pf. P S1 A price floor is a minimum legal price. The government enacts one when it is felt the market price is too low. So an effective legal minimum must be above the equilibrium price so price can not get down to the unwanted P1. Pf a b c d e P1 D1 Q Qs Qd Q1 Look up for the floor!

price floor With the price floor we see, in comparison to the normally functioning market: 1) higher price Pf, 2) lower quantity demanded - from Q1 to Qd. 3) Higher quantity supplied - Q1 to Qs. 4) surplus = Qs - Qd. 5) A lower amount traded - Qd. The amount traded has fallen because sellers can only sell what buyers buy.

price floor One thing we notice with the floor is a surplus is created. What happens to the goods that are made and not purchased? Maybe the government will buy them – the government would have to pay (Qs – Qd)times Pf to buy the surplus. Maybe the government will ask producers not to make them. Note if the price floor is below P1 then if firms tried to charge the lower price there would be a shortage. With a shortage the price rises. This means floors lower than the market price do not really impact the market – ineffective!

price ceiling P 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 the unwanted P1. S1 P1 Pc D1 The upward arrow is here to suggest price can not get above Pc. Q Qd Qs Q1 Look down from P1 for the ceiling

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

Eliminating a price support? What would happen if enough people got sick up and feed (you know, feeling ill) with price supports and had them eliminated? What would happen in the market? If there was a price floor then the quantity demanded would rise and the quantity supplied would fall and supply and demand would meet at the new lower price. If there was a price ceiling then the quantity demanded would fall and the quantity supplied would rise and supply and demand would meet at the new higher price.

price ceiling P Remember here is a price ceiling – now I will have the ceiling removed. Also remember with ceiling price is Pc and quantity traded is Qs because people can only trade what sellers sell. S1 P1 Pc D1 The upward arrow is here to suggest price can not get above Pc. Q Qd Qs Q1 On the next slide the ceiling is gone

price ceiling P With no ceiling the price will rise to P1 and the movement along the demand curve is a decrease in the quantity demanded and the movement on the supply curve is an increase in the quantity supplied. S1 P1 Pc D1 Q Qd Qs Q1 Removing the price ceiling increases price from Pc to P1, and Quantity traded rises from Qs to Q1.