price controls Flashcards
What are price controls?
The setting of minimum or maximum prices by the government (or private organisations) so that prices are unable to adjust to their equilibrium level determined by demand and supply
What do price controls cause in a market?
They result in market disequilibrium, and therefore in shortages (excess demand) and surpluses (excess supply)
Why do price controls fundamentally differ from indirect taxes and subsides?
When a tax is imposed or a subsidy granted, the market settles at a new equilibrium, but it cannot do this with price floors or ceilings
What situation do price controls force to happen?
One of persisting market disequilibrium
What does market disequilibrium mean for the market?
It means that the market is prevented from reaching a market-clearing price, and there emerge shortages or surpluses
What is a shortage?
Excess demand
What is a surplus?
Excess supply
What do shortages and surpluses involve for the market?
A misallocation of resources and welfare losses
How does excess supply (surplus) occur?
The result when quantity supplies is greater than quantity demanded
What is a price ceiling?
A legal maximum price, set by the government, for particular good
What does a price ceiling mean for the producers?
It is the price that can be legally charged by sellers of the good must not be higher than the legal maximum price
How is the equilibrium price, Pe, determined?
By the forces of demand and supply
Where does the government set the price ceiling, Pc?
At a level below the equilibrium price, leading to a shortage since Qd > Qs
What would happen if the market were free (no price controls)?
The forces of demand and supply would force price up to Pe
Why is the price ceiling set below the equilibrium?
Because if it were higher than the equilibrium price, the market would achieve equilibrium, and the price ceiling would have no effect
What impact does a price ceiling have on market outcomes?
By imposing a price that is below the equilibrium price, a price ceiling results in a lower quantity supplied and sold than at the equilibrium price
What does the price ceiling give rise to on the consumers side of the market?
A larger quantity demanded than at the equilibrium price: the quantity consumers want to buy at price Pc is given by Qd, which is greater than quantity Qe that they would buy at price Pe
What situation of disequilibrium does a price ceiling create?
One where there is a shortage (excess demand)
What happens at Pc (the price ceiling) in theory?
Not all interested buyers who are willing and able to buy the good are able to do so because there is not enough of the good being supplied
What is the shortage, after the levying of a price ceiling, equal to?
Qd – Qs
