Government Price Control Policies and Economic Efficiency

What we will learn in this class

Why does the government need price control policies?

Two price control policies: price ceiling and price floor.

Impacts of government price control policies on market outcomes.

Lessons that we can learn from government price policies.

Why does the government want to regulate market prices?

A competitive market free of government regulations is efficient when it is at equilibrium.

However, some suppliers or demanders may not be satisfied with the market equilibriums.

As a result of such dissatisfaction, they may try to lobby the government to impose price control policies.

What kind of price control policies the government may adopt?

Price ceiling (if demanders win): is a legally determined maximum price that sellers may charge.

Price floor (if suppliers win): is a legally determined minimum price that sellers may receive.

Impacts of government price control policies on market

Price ceiling: Example: Rent control

Price floor: Example: Minimum wage

Price Ceiling: Rent Control in New York City

It dates back to the housing shortage following World War II and generally applies to buildings constructed before 1947 in New York City.

Rent control is intended to protect tenants in privately-owned buildings from illegal rent increases.

Price Ceiling: Rent Control The Market for Apartments without Price

Ceiling

Equilibrium without

price controls

Equilibrium without

price controls

P

QD

SRental price of

apts

$800

300

Quantity of apartments

Price Ceiling: Rent Control The Market for Apartments with Price Ceiling

that is bindingThe eq’m price ($800) is above the ceiling and therefore illegal.

The ceiling is a binding constraint on the price, and causes a shortage.

P

QD

S

$800

Price ceiling

$500

250 400

shortage

Effects of A Binding Rent Control

A binding rent control creates

a shortage of apartments: long waiting lists.

Non-price rationing: more low income families may not be able to find an apartment to rent.

It also encourages Black Market.

Summary: market outcomes of government price ceiling policy

Price ceiling reduces market efficiency (shortage).

Non-price rationing.

In contrast, a competitive equilibrium market without price controls is more efficient.

Price Floor: Minimum Wage

Minimum wage in Pennsylvania has risen to $6.25 starting Jan. 1, 2007 and will continue to increase to $7.15 on July 1, 2007.

It has been designed to protect those with low skills, low education and teenager workers.

Price Floor: Minimum WageUnskilled labor market without minimum wage

Eq’m w/o price

controls

Eq’m w/o price

controls

W

LD

SWage paid to

unskilled workers

$4

500

Quantity of unskilled workers

Price Floor: Minimum WageUnskilled labor market with a binding

minimum wageThe equilibrium wage ($6) is below the floor and therefore illegal.The floor is a binding constraint on the wage, and causes a surplus (i.e., unemployment).

W

LD

S

$6

Price floor

$7.15

400 550

labor surplus

Market Outcomes of A Binding Minimum Wage

A binding minimum wage creates

a surplus of unskilled workers. (more unemployment).

non-price rationing: employers may discriminate certain types of job applicants.

more labor supply from teenagers: people in need may end up losing jobs.

Summary: Market outcomes of government price floor policy

Price floor reduces market efficiency (surplus).

Non-price rationing.

In contrast, the competitive equilibrium market without price floor is more efficient.

Lessons that we can learn from government price control policies

Price plays a very crucial role in our economy.

Controlling price may reduce market efficiency and may miss the policy intentions.

Alternative government policies.

Tax

Content

Tax

Tax on buyer side

Tax on seller side

Applications

Importance of tax

Tax incidence: distribution of tax When a new tax is imposed, who will pay it?

What’s the market outcomes?

When A New Tax Is Imposed on Buyers

Tax on Cigarettes

Step one Tax shift demand curve?

Step two How demand curve shifts?

Step three Compare two equilibriums

ImplicationsIf the government levies a tax on buyers Taxes reduce quantity of good sold

Buyers and sellers share the burden of taxes

Elasticity and tax on buyers

When A New Tax Is Imposed on Sellers

Taxes on oil companies BP took in 250 billion revenue last year

Step one A tax will shift supply curve?

Step two How?

Step three Compare two equilibriums

Implications

If the government levies a new tax on sellers A new tax will discourage market activities,

reducing quantity of goods sold.

Sellers and buyers share the burden of taxes

Elasticity and tax on sellers