5.1 Government-Controlled Prices

Question 1

What are Government Price controls?

Answer 1

Government price controls are policies that attempt to hold the price at some disequilibrium value.

Question 2

When controls hold the price at some disequilibrium value, what determines the quantity actually traded on the market?

Answer 2

At any disequilibrium price, quantity exchanged is determined by the lesser of quantity demanded or quantity supplied.

Question 3

What is a price floor?

Answer 3

Governments sometimes establish a price floor, which is the minimum permissible price that can be charged for a particular good or service.

Question 4

What is the effect of a price floor set at or below the equilibrium price?

Answer 4

A price floor that is set at or below the equilibrium price has no effect because the free-market equilibrium remains attainable.

Question 5

What happens if the price floor is set above the equilibrium price? What dose it mean when something is binding?

Answer 5

If, however, the price floor is set above the equilibrium, it will raise the price, in which case it is said to be binding.

Question 6

What dose a binding price floor lead to?

Answer 6

Binding price floors lead to excess supply. Either an unsold surplus will exist, or someone (usually the government) must enter the market and buy the excess supply.

Question 7

What are the consequences of excess supply if the product is a labor service?

Answer 7

The consequences of excess supply differ from product to product. If the product is labour services, subject to a minimum wage, excess supply translates into people without jobs (unemployment).

Question 8

Why might the government want to implement price floors?

Answer 8

One reason is that the people who succeed in selling their products at the price floor are better off than if they had to accept the lower equilibrium price.

If the demand is inelastic, as it often is for agricultural products, sellers earn more income in total (even though they sell fewer units of the product). The losses are spread across a large and diverse set of consumers, each of whom suffers only a small loss.

Question 9

What is a price ceiling?

Answer 9

A price ceiling is a maximum price at which certain goods and services may be legally exchanged.

Question 10

What are goods and services that have been frequently put under a price ceiling?

Answer 10

Price ceilings on oil, natural gas, and rental housing have been frequently imposed by federal and provincial governments.

Question 11

What happens if the price ceiling is above the equilibrium price?

Answer 11

If the price ceiling is set above the equilibrium price, it has no effect because the free-market equilibrium remains attainable.

Question 12

What happens if the price ceiling is below the free market equilibrium? What dose it mean when it is “binding”?

Answer 12

If, however, the price ceiling is set below the free-market equilibrium price, the price ceiling lowers the price and is said to be binding.

Question 13

What do binding price ceilings lead to?

Answer 13

Binding price ceilings lead to excess demand, with the quantity exchanged is less than in the free-market equilibrium.

Question 14

What is a “first-come, first-serve” basis?

Answer 14

If stores sell their available supplies on a first-come, first-served basis, people will rush to stores that are said to have stocks of the product. Buyers may wait hours to get into the store, only to find that supplies are exhausted before they can be served.

In market economies, “first-come, first-served” is often the basis for allocating tickets to concerts and sporting events when promoters set a price at which demand exceeds the supply of available seats.

Question 15

What is a sellers preference?

Answer 15

sellers’ preferences

Allocation of products in excess demand by decisions of the sellers.

Question 16

What dose it mean when a government rations a product?

Answer 16

If the government dislikes the allocation of products by long line-ups or by sellers’ preferences, it can choose to ration the product. To do so, it creates only enough ration coupons to match the quantity supplied at the price ceiling and then distributes the coupons to would-be purchasers, who then need both money and coupons to buy the product.

Question 17

How can rationed products be dirstributed?

Answer 17

The coupons may be distributed equally among the population or on the basis of some criterion, such as age, family status, or occupation.

Question 18

What is a black market?

Answer 18

black market

A situation in which products are sold at prices that violate a legal price control.

Question 19

Why do binding price ceilings create potential for a black market?

Answer 19

Binding price ceilings always create the potential for a black market because a profit can be made by buying at the controlled price and selling at the (illegal) black-market price.

Question 20

What are the three common goals that governments have when imposing price ceilings?

Answer 20

To restrict production (perhaps to release resources for other uses, such as wartime military production)

To keep specific prices down

To satisfy notions of equity in the consumption of a product that is temporarily in short supply (such as building supplies immediately following a natural disaster)

Question 21

Does the existence of a black market mean that the goals sought by imposing price ceilings have been thwarted?

Answer 21

To the extent that binding price ceilings give rise to a black market, it is likely that the government’s objectives motivating the imposition of the price ceiling will be thwarted.