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6 6 Supply, Demand, and Government Policies
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66Supply, Demand, and Government Policies
Copyright © 2004 South-Western/Thomson Learning
2
Supply, Demand, and Government Policies
• In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities.• Recall the trade-off between equity and efficiency
(Principle #1)• While equilibrium conditions may be efficient, it
may be true that not everyone is satisfied.
• One of the roles of economists is to use their theories to assist in the development of policies.
Copyright © 2004 South-Western/Thomson Learning
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PRICE CONTROLS
• Usually enacted when policymakers believe the market price is unfair to buyers or sellers.
• Result in government-created price ceilings and price floors.
Copyright © 2004 South-Western/Thomson Learning
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CONTROLS ON PRICES
• Price Ceiling • A legal maximum on the price at which a good can
be sold.
• Price Floor• A legal minimum on the price at which a good can
be sold.
Copyright © 2004 South-Western/Thomson Learning
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How Price Ceilings Affect Market Outcomes
• Two outcomes are possible when the
government imposes a price ceiling:
• The price ceiling is not binding if set above the
equilibrium price.
• The price ceiling is binding if set below the
equilibrium price, leading to a shortage.
Figure 1 A Market with a Price Ceiling
(a) A Price Ceiling That Is Not Binding
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
Equilibriumquantity
$4 Priceceiling
Equilibriumprice
Demand
Supply
3
100
Figure 1 A Market with a Price Ceiling
Copyright©2003 Southwestern/Thomson Learning
(b) A Price Ceiling That Is Binding
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
Demand
Supply
2 PriceceilingShortage
75
Quantitysupplied
125
Quantitydemanded
Equilibriumprice
$3
Copyright © 2004 South-Western/Thomson Learning
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How Price Ceilings Affect Market Outcomes
• Effects of Price Ceilings
• A binding price ceiling leads to
• Shortages because QD > QS.
• Examples: • Gasoline shortage of the 1970s
• Rental housing shortages in rent-controlled cities
• If a shortage for a product occurs (and price cannot adjust to eliminate it), a method for rationing the good must develop.
• Nonprice rationing• Examples: Long lines, discrimination by sellers
• Not all buyers benefit from a price ceiling since some will be unable to purchase the product.
Copyright © 2004 South-Western/Thomson Learning
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• In 1973, OPEC raised the price of crude oil in world markets. Crude oil is the major input in gasoline, so the higher oil prices reduced the supply of gasoline.
• What was responsible for the long gas lines?
CASE STUDY: Lines at the Gas Pump
• Economists blame government regulations that limited the price oil companies could charge for gasoline.
The Market for Gasoline with a Price Ceiling
Copyright©2003 Southwestern/Thomson Learning
(a) The Price Ceiling on Gasoline Is Not Binding
Quantity ofGasoline
0
Price ofGasoline
1. Initially,the priceceilingis notbinding . . . Price ceiling
Demand
Supply, S1
P1
Q1
The Market for Gasoline with a Price Ceiling
Copyright©2003 Southwestern/Thomson Learning
(b) The Price Ceiling on Gasoline Is Binding
Quantity ofGasoline
0
Price ofGasoline
Demand
S1
S2
Price ceiling
QS
4. . . . resultingin ashortage.
3. . . . the priceceiling becomesbinding . . .
2. . . . but whensupply falls . . .
P2
QD
P1
Q1
Copyright © 2004 South-Western/Thomson Learning
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CASE STUDY: Rent Control in the Short Run and Long Run
• Rent controls are ceilings placed on the rents that landlords may charge their tenants.• The goal of rent control policy is to help the poor by making
housing more affordable.
• One economist called rent control “the best way to destroy a city, other than bombing.” Why?• Long waiting lists
• Discrimination • race, number of children, smoking habits, pets.
• Bribery• superintendents get the bribes equal to the difference between the
equilibrium market rent and the controlled rent.
Rent Control in the Short Run
Copyright©2003 Southwestern/Thomson Learning
In the short run, both supply and demand are inelastic. Therefore, primary effect of rent control is to reduce rent. The shortage is relatively small.
Number ofApartments0
Supply
Controlled rent
RentalPrice of
Apartment
Demand
Shortage
Rent Control in the Long Run
Copyright©2003 Southwestern/Thomson Learning
In the long run, the local stock of housing and the population can change. Therefore, local supply and demand for rental housing are elastic in the long run.=> Shortage is large.
0
RentalPrice of
Apartment
Number ofApartments
Demand
Supply
Controlled rent
Shortage
Copyright © 2004 South-Western/Thomson Learning
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Rental Market for 2-bedroom apartments in Midtown Atlanta
0
RentalPrice of
2 bedroomApartment
Number of 2 bedroomApartment Units
Demand
Supply
$1,200
20,000 40,0008,000
Controlled rent
Shortage
$1,000
Is this rent control policy good for the Georgia Tech Students?
