1. Chapter 6 PRICE CEILINGS AND PRICE FLOORS Gottheil Principles of Economics, 7e © 2013 Cengage Learning 1

2. Economic Principles Government intervention in markets Price ceilings Price floors Parity pricing Target prices Crop limitation programs © 2013 Cengage Learning Gottheil Principles of Economics, 7e 2

3. EXHIBIT 1PRODUCTION POSSIBILITIES CURVE FOR CIVILIAN AND DEFENSE GOODS © 2013 Cengage Learning Gottheil Principles of Economics, 7e 3

4. Exhibit 1: Production Possibilities Curve for Civilian and Defense Goods © 2013 Cengage Learning Gottheil Principles of Economics, 7e 4 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.

5. Exhibit 1: Production Possibilities Curve for Civilian and Defense Goods © 2013 Cengage Learning Gottheil Principles of Economics, 7e 5 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.

6. EXHIBIT 2THE FISH MARKET BEFORE AND AFTER THE DRAFT © 2013 Cengage Learning Gottheil Principles of Economics, 7e 6

7. Exhibit 2: The Market Before and After the Draft © 2013 Cengage Learning Gottheil Principles of Economics, 7e 7 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.

8. Exhibit 2: The Market Before and After the Draft © 2013 Cengage Learning Gottheil Principles of Economics, 7e 8 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.

9. Exhibit 2: The Market Before and After the Draft © 2013 Cengage Learning Gottheil Principles of Economics, 7e 9 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.

10. Exhibit 2: The Market Before and After the Draft © 2013 Cengage Learning Gottheil Principles of Economics, 7e 10 Postdraft, the equilibrium price of fish: The equilibrium price of fish increases from $4 to $10 after the draft.

11. Exhibit 2: The Market Before and After the Draft © 2013 Cengage Learning Gottheil Principles of Economics, 7e 11 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.

12. Exhibit 2: The Market Before and After the Draft © 2013 Cengage Learning Gottheil Principles of Economics, 7e 12 The greater burden of the increased price for fish is felt by: The poor The rich

13. Exhibit 2: The Market Before and After the Draft © 2013 Cengage Learning Gottheil Principles of Economics, 7e 13 The greater burden of the increased price for fish is felt by: The poor The rich

14. Exhibit 2: The Market Before and After the Draft © 2013 Cengage Learning Gottheil Principles of Economics, 7e 14 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.

15. Price Ceiling © 2013 Cengage Learning Gottheil Principles of Economics, 7e 15 Price ceiling A maximum price set by government below the market-generated equilibrium price.

16. EXHIBIT 3SETTING A $4 PRICE CEILING IN THE FISH MARKET © 2013 Cengage Learning Gottheil Principles of Economics, 7e 16

17. Exhibit 3: Setting a $4 Price Ceiling in the Fish Market © 2013 Cengage Learning Gottheil Principles of Economics, 7e 17 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.

18. Exhibit 3: Setting a $4 Price Ceiling in the Fish Market © 2013 Cengage Learning Gottheil Principles of Economics, 7e 18 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.

19. Exhibit 3: Setting a $4 Price Ceiling in the Fish Market © 2013 Cengage Learning Gottheil Principles of Economics, 7e 19 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.

20. Exhibit 3: Setting a $4 Price Ceiling in the Fish Market © 2013 Cengage Learning Gottheil Principles of Economics, 7e 20 Allocate a shortage of goods: One method is through the use of ration coupons.

21. Exhibit 3: Setting a $4 Price Ceiling in the Fish Market © 2013 Cengage Learning Gottheil Principles of Economics, 7e 21 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.

22. Exhibit 3: Setting a $4 Price Ceiling in the Fish Market © 2013 Cengage Learning Gottheil Principles of Economics, 7e 22 Allocate a shortage of goods: Ration coupons may be issued based on schemes such as: First come, first served Lottery Household size

23. Price Ceiling and Housing © 2013 Cengage Learning Gottheil Principles of Economics, 7e 23 Rent control is a government-set price ceiling on rent.

24. Price Ceiling and Housing © 2013 Cengage Learning Gottheil Principles of Economics, 7e 24 Arguments against rent control: It dampens landlords incentives to properly maintain their existing rental units. It discourages many people from investing in new construction.

25. Price Floors © 2013 Cengage Learning Gottheil Principles of Economics, 7e 25 Price floor A minimum price set by government above the market-generated equilibrium price.

26. EXHIBIT 4EFFECT OF NEW TECHNOLOGY ON THE FISH MARKET © 2013 Cengage Learning Gottheil Principles of Economics, 7e 26

27. Exhibit 4: Effect of New Technology on the Fish Market © 2013 Cengage Learning Gottheil Principles of Economics, 7e 27 When a new technology is adopted, the supply curve in the fish market: The supply curve shifts the the right.

28. Exhibit 4: Effect of New Technology on the Fish Market © 2013 Cengage Learning Gottheil Principles of Economics, 7e 28 After adopting the new technology, total revenue for the fisherman: Total revenue decreases.

29. Exhibit 4: Effect of New Technology on the Fish Market © 2013 Cengage Learning Gottheil Principles of Economics, 7e 29 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.

30. Exhibit 4: Effect of New Technology on the Fish Market © 2013 Cengage Learning Gottheil Principles of Economics, 7e 30 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.

31. EXHIBIT 5SETTING A $4 PRICE FLOOR IN THE FISH MARKET © 2013 Cengage Learning Gottheil Principles of Economics, 7e 31

32. Exhibit 5: Setting a $4 Price Floor in the Fish Market © 2013 Cengage Learning Gottheil Principles of Economics, 7e 32 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.

33. Exhibit 5: Setting a $4 Price Floor in the Fish Market © 2013 Cengage Learning Gottheil Principles of Economics, 7e 33 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.

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. © 2013 Cengage Learning Gottheil Principles of Economics, 7e 34

35. Exhibit 6: Growth of U.S. Agricultural Productivity Throughout U.S. History © 2013 Cengage Learning Gottheil Principles of Economics, 7e 35 Agricultural productivity has increased in the U.S. because: Changes in the dominant energy source technology used on farms.

36. Exhibit 6: Growth of U.S. Agricultural Productivity Throughout U.S. History © 2013 Cengage Learning Gottheil Principles of Economics, 7e 36 Agricultural productivity has increased in the U.S. because: Advances in modern chemistry to produce fertilizers, insecticides, crop ripeners and food preservatives.

37. EXHIBIT 7EFFECT OF NEW TECHNOLOGY IN FARMING © 2013 Cengage Learning Gottheil Principles of Economics, 7e 37

38. Exhibit 7: Effect of New Technology in Farming © 2013 Cengage Learning Gottheil Principles of Economics, 7e 38 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.

39. Parity Pricing © 2013 Cengage Learning Gottheil Principles of Economics, 7e 39 Parity pricing Parity pricing describes one criteria used to determine the level at which a price floor should be set.

40. Parity Pricing © 2013 Cengage Learning Gottheil Principles of Economics, 7e 40 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

41. Parity Pricing © 2013 Cengage Learning Gottheil Principles of Economics, 7e 41 Parity pricing was adopted by the government in 1933 when Congress passed the Agricultural Adjustment Act. Parity pricing

42. EXHIBIT 8 SHOES AND CORN: SHIFTS IN DEMAND AND SUPPLY: 1914–2004 © 2013 Cengage Learning Gottheil Principles of Economics, 7e 42

43. Exhibit 8: Shoes and Corn: Shifts in Demand and Supply: 1914-2004 © 2013 Cengage Learning Gottheil Principles of Economics, 7e 43 In Exhibit 8, the market for shoes changes from 1914 to 2004: While the supply curve for shoes remained unchanged, the demand curve for shoes shifted to the right.

44. Exhibit 8: Shoes and Corn: Shifts in Demand and Supply: 1914-2004 © 2013 Cengage Learning Gottheil Principles of Economics, 7e 44 In Exhibit 8, the market for shoes changes from 1914 to 2004: The shift in demand raised the equilibrium price for shoes from $2 to $4.

45. Exhibit 8: Shoes and Corn: Shifts in Demand and Supply: 1914-2004 © 2013 Cengage Learning Gottheil Principles of Economics, 7e 45 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.

46. Exhibit 8: Shoes and Corn: Shifts in Demand and Supply: 1914-2004 © 2013 Cengage Learning Gottheil Principles of Economics, 7e 46 The market for corn changed in the same time period: The equilibrium price of corn declined from $2 in 1914 to $1 in 2004.

47. Exhibit 8: Shoes and Corn: Shifts in Demand and Supply: 1914-2004 © 2013 Cengage Learning Gottheil Principles of Economics, 7e 47 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.

48. Exhibit 8: Shoes and Corn: Shifts in Demand and Supply: 1914-2004 © 2013 Cengage Learning Gottheil Principles of Economics, 7e 48 Parity pricing affects the quantity of corn demanded and supplied: It also creates an excess supply of 50 million bushels of corn.

49. Parity Price Ratio © 2013 Cengage Learning Gottheil Principles of Economics, 7e 49 Parity price ratio The relationship between prices received by farmers and prices paid by farmers.

50. EXHIBIT 9PARITY PRICE RATIOS OF PRICES RECEIVED AND PAID BY FARMERS: 1910–2000 © 2013 Cengage Learning Gottheil Principles of Economics, 7e 50

51. Exhibit 9: Parity Price Ratios of Prices Received by Farmers and Paid by Farmers: 1910–2000 © 2013 Cengage Learning Gottheil Principles of Economics, 7e 51 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.

52. Freedom to Farm Act of 1996 © 2013 Cengage Learning Gottheil Principles of Economics, 7e 52 Freedom to Farm Act of 1996 Legislation enacted by Congress that phases in, over a 7-year transitional period, the complete dismantling of the governments farm price support and crop restriction systems.

53. EXHIBIT 10Farm Bill Legislation: 1933–2008 © 2013 Cengage Learning Gottheil Principles of Economics, 7e 53

54. The Farm Bill of 2008 © 2013 Cengage Learning Gottheil Principles of Economics, 7e 54 Farm Bill of 2008 The Food, Conservation, and Energy Act of 2008 continues the 2002 Farm Act and likewise covers income and commodity price support, land conservation, water and farmland protection and development of rural renewable energy sources. The cost of the bill for its 5-year term is about $300 billion.

55. Farm Subsidies around the World © 2013 Cengage Learning Gottheil Principles of Economics, 7e 55 Source: Organization for Economic Cooperation and Development.

56. A Long Tradition of Price Ceilings and Price Floors © 2013 Cengage Learning Gottheil Principles of Economics, 7e 56 Usury Originally, the charging of interest on loans, but it has come to mean the charging of unreasonably high rates of interest. Usury laws have been enacted to fix the maximum price of borrowing money since ancient times.