Price Ceilings

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Price ceiling
This is an example of government
intervention in a market.
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P
P1
D
Q1
Q
The height of the demand curve at any quantity
is the most anyone would pay for that unit. We
can call it the reservation price – it is the highest
price that could occur for the unit and have
someone still call in a reservation to get the
unit. In this graph at Q1 we see P1 is the most
someone is willing to pay for this unit. On all
the units before Q1, some consumers are willing
to pay even more than P1. Units after Q1 are
not demanded when the price is P1 because
consumers are not willing to pay P1 for those
units.
On the last unit, Q1, sometimes called the marginal unit, the
price P1 is the value on the last unit. Thus with a price of P1, all
units of equal or greater value are demanded.
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P
The height of the supply curve at any
quantity is the least any supplier
would take for that unit. We can call it
P1
the reservation price. In this graph at
Q1 we see P1 is the least someone is
Q
willing to accept for this unit. On all
Q1
the units before Q1, some sellers are
willing to receive less than P1. Units
after Q1 are not supplied when the
price is P1 because sellers need more
then P1 for those units.
On the last unit, Q1, sometimes called the marginal unit, the price
P1 is the value on the last unit. Thus with a price of P1, all units of
equal or lower value are supplied.
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price ceiling
P
S1
P1
Pc
The upward
arrow is here to
suggest price can
not get above Pc.
D1
Qs
Q1 Qd
Q
A price ceiling is a
maximum legal price.
The government
enacts one when it is
felt the market price
is too high. So an
effective legal
maximum must be
below the
equilibrium price.
Price can then not
legally get to P1.
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With the price ceiling we see:
1) lower price Pc,
price ceiling
2) lower quantity supplied - from Q1 to Qs. This is really
also the amount traded. The amount traded has fallen
because buyers can only buy what sellers sell.
3) Higher quantity demanded - Q1 to Qd.
4) shortage = Qd - Qs.
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price ceiling
P
Note again that the
amount traded will
be Qs. And the price
ceiling is Pc, so this is
the price charged in
the market.
S1
Pw
P1
Pc
D1
Qs
Q1 Qd
Q
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Note on the previous graph I have a solid vertical line above the
quantity 1 unit higher than Qs. Note the height of the demand
curve here. This is what some demander is willing to pay for this
unit. The height of the supply curve is what some seller is willing
to receive on this unit. As an example, say someone is willing to
pay 10 for the unit and a seller is willing to accept about 3.50.
Can both the buyer and the seller of this unit benefit? Sure – like
say they trade the unit for 5. Each benefits and you see the surplus
of each is 5 and 1.50, respectively.
Are any of the folks involved in the Qs units traded made worse off
by allowing this extra unit to be traded? No, maybe they could be
better off, but they are not worse off.
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Efficient
A situation is efficient if no change is possible that will help some
people without harming others.
I add this: If Price and quantity take anything other than their
equilibrium values, a transaction that will make at least some
people better off without harming others can always be found.
So, price ceilings are inefficient. A change is possible that will help
some without harming others.
There is another problem with a price ceiling
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price ceiling
P
S1
P1
Pc
The upward
arrow is here to
suggest price can
not get above Pc.
This screen is a repo of a
previous screen.
Imagine you are sitting
at P1, do it! Where do
you look for the ceiling?
Down! Why not up?
A ceiling above P1
would cause a surplus
and we know with a
Q
Qs Q1 Qd
surplus the price will
fall. It would fall to P1.
Price ceilings above equilibrium are not binding
D1
Or are not effective!
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Vertical Supply
P
S
P1
Pc
D
Q1
Q
Qd
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Vertical Supply
Many times after a sports team issues tickets to a game a market
develops for tickets to the game. Suppliers in this market actually
already have a ticket, but may sell it. The supply in this case is a
vertical line at the amount of tickets folks are willing to part with –
we note the price could be almost any level, but now higher prices
do not elicit a higher quantity supplied. Supply is fixed at the
“capacity” of folks willing to give up tickets.
On the previous slide with the supply we see the demand would
lead to a market price of P1.
Many places say you can not “scalp” a ticket for more than the
price on the ticket.
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Vertical supply
If the price on the ticket is an effective ceiling then we have some
situations created.
1) An excess demand for tickets is created. This means more people
want tickets than there are tickets available. Qd minus Q1 represents
the demand from people who value tickets less than P1 in price. In
fact, the closer we get to Q1 the less people value the ticket because
they are only willing to pay a lower price to get the ticket.
Qd minus 0 represents the demand from people who even value the
ticket more than P1.
If anyone up to Q1 units offers Pc the seller would take it. But the
seller doesn’t know if the person buying the ticket values it more than
PC. It is possible that tickets do not go to those who value the ticket
most.
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Vertical supply
2) Mutually beneficial trade may be eliminated. Many folks are
willing to pay more than Pc for the ticket and the seller may value the
ticket at most Pc. Say a buyer is willing to pay 100 for the ticket and
the seller values the ticket at 15. If the two negotiate a price of 70 the
buyer gets the ticket for 30 less than they value it and the seller gets
55 more than it is worth to them.
But, if the trade can be no higher than 15 then maybe the trade
doesn’t occur.
Here is the last point – to overcome this last point maybe the seller
says you can have the ticket if you give me 15 (the ceiling) plus you
give me 55 for a pencil. The buyer is still happier by 30 and the
seller is happier by 55.
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