© 2005 Thomson C hapter 6 Price Ceilings and Price Floors.

© 2005 Thomson

CChapter 6hapter 6

Price Ceilings and Price Ceilings and Price FloorsPrice Floors

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Gottheil - Principles of Economics, 4e

Economic PrinciplesEconomic Principles

Government intervention in markets

Price ceilings

Price floors

Parity pricing

Target prices

Crop limitation programs

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EXHIBIT 1 PRODUCTION POSSIBILITIES CURVE FOR CIVILIAN AND DEFENSE GOODS

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Exhibit 1: Production Exhibit 1: Production Possibilities Curve for Possibilities Curve for

Civilian and Defense GoodsCivilian 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.

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Exhibit 1: Production Exhibit 1: Production Possibilities Curve for Possibilities Curve for

Civilian and Defense GoodsCivilian 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.

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EXHIBIT 2 THE FISH MARKET BEFORE AND AFTER THE DRAFT

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Exhibit 2: The Market Before Exhibit 2: The Market Before and After the Draftand After the Draft

In Exhibit 2, the community’s predraft and postdraft demand for fish does not change.• Demand for fish doesn’t change just because there’s a national security problem.

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In Exhibit 2, the community’s predraft and postdraft demand for fish does not change.• Note that the demand curves before and after the supply curve has shifted are identical.

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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.

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Postdraft, the equilibrium price of fish:

• The equilibrium price of fish increases from $4 to $10 after the draft.

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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.

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The greater burden of the increased price for fish is felt by:

• The poor

• The rich

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The greater burden of the increased price for fish is felt by:

• The poor

• The rich

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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.

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Price CeilingPrice Ceiling

Price ceiling

• A maximum price set by government below the market-generated equilibrium price.

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EXHIBIT 3 SETTING A $4 PRICE CEILING IN THE FISH MARKET

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Exhibit 3: Setting a Exhibit 3: Setting a $4 Price Ceiling in the $4 Price Ceiling in the

Fish MarketFish MarketIn 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.

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Fish MarketFish MarketIn 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.

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Fish MarketFish MarketIn Exhibit 3, when a $4 price ceiling is set, the market for fish:• Based on the postdraft supply curve, there is a shortage—an unsatisfied excess demand—of 6,000 fish.

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Fish MarketFish MarketAllocate a shortage of goods:

• One method is through the use of ration coupons.

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• Ration coupons are issued by the government, entitling the holder to purchase a specific quantity of a good at or below the price ceiling.

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Ration coupons may be issued based on schemes such as:

• First come, first served.

• Lottery.

• Household size.

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Price Ceiling and Price Ceiling and HousingHousing

Rent control is a government-set price ceiling on rent.

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Price Ceiling and Price Ceiling and HousingHousing

Arguments against rent control:

• It dampens landlords’ incentives to properly maintain their existing rental units.

• It discourages many people from investing in new construction.

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Price FloorsPrice Floors

Price floor

• A minimum price set by government above the market-generated equilibrium price.

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EXHIBIT 4 EFFECT OF NEW TECHNOLOGY ON THE FISH MARKET

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Exhibit 4: Effect of New Exhibit 4: Effect of New Technology on the Fish Technology on the Fish

MarketMarketWhen a new technology is adopted, the supply curve in the fish market:

• The supply curve shifts the the right.

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MarketMarketAfter adopting the new technology, total revenue for the fisherman:

• Total revenue decreases.

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• 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.

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• After adopting the new technology, 12,000 fish are sold at an equilibrium price of $2 each, for a total revenue of $24,000.

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EXHIBIT 5 SETTING A $4 PRICE FLOOR IN THE FISH MARKET

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Exhibit 5: Setting a $4 Exhibit 5: Setting a $4 Price Floor in the Fish Price Floor in the Fish

MarketMarketIn 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.

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Exhibit 5: Setting a $4 Exhibit 5: Setting a $4 Price Floor in the Fish Price Floor in the Fish

MarketMarketThe 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.

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EXHIBIT 6 GROWTH OF U.S. AGRICULTURAL PRODUCTIVITY THROUGHOUT U.S. HISTORY

* Precise data are not available.

Source: James Zelner and R.M. Lamm, “Agriculture’s Vital Role for Us All,” Food—From Farm to Table, 1982 Yearbook of Agriculture, Department of Agriculture, Washington, D.C., p. 3.

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Exhibit 6: Growth of US Exhibit 6: Growth of US Agricultural Productivity Agricultural Productivity Throughout U.S. HistoryThroughout U.S. History

Agricultural productivity has increased in the U.S. because:

• Changes in the dominant energy source technology used on farms.

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Exhibit 6: Growth of US Exhibit 6: Growth of US Agricultural Productivity Agricultural Productivity Throughout U.S. HistoryThroughout U.S. History

Agricultural productivity has increased in the US because:• Advances in modern chemistry to produce fertilizers, insecticides, crop ripeners and food preservatives.

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EXHIBIT 7 NUMBER 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.

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Exhibit 7: Number and Size Exhibit 7: Number and Size of U.S. Farmsof 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.

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Exhibit 7: Number and Size Exhibit 7: Number and Size of U.S. Farmsof 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.

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EXHIBIT 8 INDEXES OF TOTAL FARM OUTPUT: 1950–99 (1996 = 100)

Source: Economic Report of the President, 2003, Washington, D.C., p. 439.

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Exhibit 8: Indexes of Total Exhibit 8: Indexes of Total Farm Output: 1950-99 Farm Output: 1950-99

(1996 = 100)(1996 = 100)

Total farm output in the U.S. between 1950 and 1999 almost:

• Fell by one-half

• Doubled

• Tripled

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Exhibit 8: Indexes of Total Exhibit 8: Indexes of Total Farm Output: 1950-99 Farm Output: 1950-99

(1996 = 100)(1996 = 100)

Total farm output in the U.S. between 1950 and 1999 almost:• Fell by one-half

• Doubled

• Tripled

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EXHIBIT 9 EFFECT OF NEW TECHNOLOGY IN FARMING

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Exhibit 9: Effect of New Exhibit 9: Effect of New Technology in FarmingTechnology 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.

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Parity pricing

• Parity pricing describes one criteria used to determine the level at which a price floor should be set.

Parity PricingParity Pricing

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• 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


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• Parity pricing was adopted by the government in 1933 when Congress passed the Agricultural Adjustment Act.

Parity pricing

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EXHIBIT 10SHOES AND CORN: SHIFTS IN DEMANDAND SUPPLY: 1914–2000

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Exhibit 10: Shoes and Corn: Exhibit 10: Shoes and Corn: Shifts in Demand and Shifts in Demand and

Supply: 1914-2000Supply: 1914-2000

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.

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Supply: 1914-64Supply: 1914-64

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.

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Supply: 1914-2000Supply: 1914-2000

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.

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Supply: 1914-2000Supply: 1914-2000

The market for corn changed in the same time period:• The equilibrium price of corn declined from $2 in 1914 to $1 in 1964.

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Supply: 1914-2000Supply: 1914-2000

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.

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Supply: 1914-2000Supply: 1914-2000

Parity pricing affects the quantity of corn demanded and supplied:• It also creates an excess supply of 50 million bushels of corn.

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Parity Price RatioParity Price Ratio

Parity price ratio

• The relationship between prices received by farmers and prices paid by farmers.

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

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Exhibit 11: Parity Price Exhibit 11: Parity Price Ratios of Prices Received by Ratios of Prices Received by

Farmers and Paid by Farmers and Paid by Farmers: 1910-2000Farmers: 1910-2000

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.

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Commodity Credit Commodity Credit CorporationCorporation

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.

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Commodity Credit Commodity Credit Corporation’s Loans: Corporation’s Loans:

Public Law 480Public Law 480In 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.

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Target PriceTarget Price

Target price

• A minimum price level for specific farm goods that the government sets and guarantees.

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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.

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Target price

• Congress moved from parity pricing to setting target prices in 1973 with the passage of the Agricultural and Consumer Protection Act.

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EXHIBIT 12 COMPARING THE OUTCOMES OF PARITY AND TARGET PRICING

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Exhibit 12: Comparing the Exhibit 12: Comparing the Outcomes of Parity and Outcomes of Parity and

Target PricingTarget PricingGovernment 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.

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Target PricingTarget PricingGovernment 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.

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Target PricingTarget PricingThe 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.

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Target PricingTarget PricingThe 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.

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