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11/19/2016

EconPortPriceFloorsandCeilings

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PriceFloorsandCeilings

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PriceFloorsandPriceCeilingsarePriceControls,examplesofgovernmentinterventioninthefree
marketwhichchangesthemarketequilibrium.Theyeachhavereasonsforusingthem,butthere
arelargeefficiencylosseswithbothofthem.
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PriceFloors

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PriceFloorsareminimumpricessetbythegovernmentforcertaincommoditiesandservicesthatit
believesarebeingsoldinanunfairmarketwithtoolowofapriceandthustheirproducersdeserve

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someassistance.Pricefloorsareonlyanissuewhentheyaresetabovetheequilibriumprice,since
theyhavenoeffectiftheyaresetbelowmarketclearingprice.

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Whentheyaresetabovethemarketprice,thenthereisapossibilitythattherewillbeanexcess
supplyorasurplus.Ifthishappens,producerswhocan'tforeseetroubleaheadwillproducethe
largerquantitywherethenewpriceintersectstheirsupplycurve.Unbeknownsttothem,consumers
willnotbuythatmanygoodsatthehigherpriceandsothosegoodswillgounsold.
Therewillbeeconomicharmdoneevenifsupplierscanlookaheadandseethatthereisn't
sufficientdemandandcutbackonproductioninresponse.Thereisstilldeadweightlossassociated
withthisreductioninquantity,reflectedinthelossofconsumerandproducersurplusatlowerlevels
ofproduction.Producerscangainasaresultofthispolicy,butonlyiftheirsupplycurveisrelatively
elasticandthereforetheyhavenonetloss.Consumerswilldefinitelylosewiththiskindof
regulation,assomepeoplearepricedoutofthemarketandothershavetopayahigherpricethan
before.
Therearenumerousstrategiesofthegovernmentforsettingapriceflooranddealingwithits
repercussions.Theycansetasimplepricefloor,useapricesupport,orsetproductionquotas.Price
supportssetsaminimumpricejustlikeasbefore,butherethegovernmentbuysupanyexcess
supply.Thisisevenmoreinefficientandcostlyforthegovernmentandsocietyasawholethanthe
governmentdirectlysubsidizingtheaffectedfirms.Productionquotasartificiallyraisethepriceby
restrictingproductionusingeithermandatedquotasorgivingbusinessesincentivestoreducetheir
production.InAmerica,thislattertechniqueisusedwidelywithagriculture.Thegovernmentpays
farmerstokeepsomeportionoftheirfieldsfallow,thuselevatingprices.Likepricesupports,the
policywouldbemoreefficientandlesscostlytosocietyifthegovernmentdirectlysubsidized
farmersinsteadofsettingaproductionrestriction.

PriceCeilings

http://www.econport.org/content/handbook/Equilibrium/PriceControls.html

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11/19/2016

EconPortPriceFloorsandCeilings

PriceCeilingsaremaximumpricessetbythegovernmentforparticulargoodsandservicesthat
theybelievearebeingsoldattoohighofapriceandthusconsumersneedsomehelppurchasing
them.Priceceilingsonlybecomeaproblemwhentheyaresetbelowthemarketequilibriumprice.
Whentheceilingissetbelowthemarketprice,therewillbeexcessdemandorasupplyshortage.
Producerswon'tproduceasmuchatthelowerprice,whileconsumerswilldemandmorebecause
thegoodsarecheaper.Demandwilloutstripsupply,sotherewillbealotofpeoplewhowanttobuy
atthislowerpricebutcan't.Still,ifthedemandcurveisrelativelyelastic,thentheneteffectto
consumersurpluswillbepositive.Producersaretrulyharmed,astheirsurplusisdoublyhitwitha
reductioninthenumberoffirmswillingtotakethatlowerprice,andthosewhoremaininthemarket
havetotakealowerprice.
Theresultingshortageofgoodscanleadtoconsumershavingtoqueueupinlinetogetthegood,
governmentrationing,andeventhedevelopmentofablackmarketdealingwiththescarcegoods.
ThisiswhatoccurredwiththeenergycrisisinAmericaduringthe1970s,whencarshadtolineup
onthestreetinordertojustgetsomegovernmentrationedamountofgasoline.

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Copyright2006ExperimentalEconomicsCenter.Allrightsreserved.

http://www.econport.org/content/handbook/Equilibrium/PriceControls.html

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