4.5 Price Controls

  1. Consider a supply curve given by the equation \(p = \frac{q}{20}\) and a demand curve given by \(p = 25 - \frac{q}{20}\).
    1. Use ggplot and stat_function to draw these curves on the same plot.
    2. Find the equilibrium price and quantity exchanged by visual inspection of the plot.

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library(tidyverse)

Price Ceilings

A price is a signal wrapped in an incentive, conveying information about scarcity and value while encouraging producers to supply more and consumers to demand less. This balance ensures efficient resource allocation, maximizing total surplus. However, price controls, like price ceilings and price floors, disrupt this balance. A price ceiling sets a maximum legal price, often intended to make goods affordable but frequently causing unintended harm. Consequences include shortages, reduced product quality, lines, search costs, deadweight loss, and resource misallocation. Conversely, a price floor sets a minimum price, often aimed at protecting producers or workers but potentially leading to surpluses or unemployment.

Real-life examples of price ceilings include rent control policies in cities like New York and San Francisco. These laws cap rental prices to make housing more affordable but often result in housing shortages, reduced maintenance, and long waiting lists. Similarly, during the 1970s oil crisis, the U.S. imposed price ceilings on gasoline, leading to widespread shortages, long lines at gas stations, and rationing.

Price floors are exemplified by minimum wage laws, which set a baseline for hourly pay to ensure workers earn a living wage. While this helps some workers, it can also lead to higher unemployment, as employers may hire fewer workers or cut hours to offset increased labor costs. Another example is agricultural price supports, where governments set minimum prices for crops like wheat or milk to protect farmers. While this stabilizes farmers’ incomes, it can lead to overproduction and wasted resources.

Both price ceilings and floors demonstrate how government interventions, while well-intentioned, can create inefficiencies and unintended consequences in markets.

  1. Continuing from question 1, suppose the government imposes a $5 price ceiling on the market. That is, you can’t sell the good for more than $5. This prevents the market from reaching equilibrium.

    1. Take your plot from question 1 and add a horizontal line at a price of $5 to represent the price ceiling.

    2. At the price of $5, the quantity demanded is ___ and the quantity supplied is ___. There is a (surplus/shortage). In response, sellers realize they can cut product quality and still sell everything they want to sell. Buyers form long lines and waste time and money searching for ways to get at least a little of the good.

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Time Wasted in Lines

  1. Search Costs

    1. Continuing from question 2: buyers are willing to pay ___ for the 100th unit, but the price is capped at $5. If they can get it, it’s a great deal, which is why buyers are willing to wait in long lines.
    2. The line will grow until the time price plus the money price is equal to the willingness to pay you found in part A. So the time price will be equal to the willingness to pay minus the money price of $5. Calculate the time price.
    3. The total value of wasted time is the time price times the quantity sold. Calculate this.
    4. Why is it better to have an economic system where people pay in money versus pay in time?

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Misallocation of Resources

  1. Give an example of how price ceilings misallocate resources, keeping the people who need the good the most from being able to access it.

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Rent Controls

  1. In the short run, the supply of housing is very (elastic/inelastic). But in the long run, the supply of housing becomes much more (elastic/inelastic). So in a place like NYC or San Francisco with rent-controlled apartments, we should expect the housing shortage to get (more extreme/less extreme) in the long-run. We should also expect the deterioration of housing to get (more extreme/less extreme) in the long-run.

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Minimum Wage

  1. The minimum wage is an example of a (price ceiling/price floor). It creates a labor (surplus/shortage), which translates to higher unemployment, especially for (low/high) skilled workers.

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