Principles of Economics - Microeconomics

Price Ceiling

Price ceiling - Maximum price allowed by law.

Effects of price ceiling

  • Shortages
  • Bad quality
  • Lines and search costs
  • Deadweight loss
  • Misallocation of resources

Price Ceiling

Bad Quality

Main effect of price ceiling is that QDemanded > QSupplied. Sellers have more customers so

  • They can cut quality, cut costs and still able to sell at the same mandated price.
  • They can provide worse service and still be able to sell.
Lines and search costs
  • Price control does not reduce quantity demanded.
  • Consumers outnumber sellers.
  • This incentivises consumers who value a good more to pay bribes to buy it.
  • More consumers than suppliers leads to lines and increase in time cost.
  • Paying in time is wasteful as time is a perishable resource.

Line costs

Deadweight loss

Due to price control, not all profitable trades are made, so there is a deadweight loss.

Misallocation of resources

The key benefit of free market and the pricing system is that

We want to ensure that consumers who value a good more can secure supply before consumers who value it less.

Example -

  • Gold and silver are used in many electrical and electronics manufacturing. It is also used as jewellery.
  • If government puts a max price on gold, some of the supply that should have gone to electrical and electronics manufacturing goes to jewellery.
  • Manufacturers can not signal to the market that they value gold more by paying a higher price to secure supplies, as there is a price ceiling.
  • This leads to shortages in manufacturing and instead allocates resources for jewellery which is not as important area.

Price system ensures that most important and hence most valued consumers of good are last to be affected by shortages.

Misallocation of resources

Rent controls

  • It is a type of a price ceiling.
  • Makes it difficult to find apartments.
  • Often rent controlled apartments are rented by people who do not need them.
  • Creates shortages in supply of apartment buildings.
  • Over time due to fund shortages rent controlled buildings become decrepit, unmaintained, and dangerous. Many rent controlled buildings fall down in Mumbai, killing people.

Price floors

Minimum price allowed by law.

Effect of price floors

  • They create surpluses.
  • Lost gains.
  • Wasteful increase in quality.
  • Misallocation of resources.

Floors are less common.

Minimum wage

Minimum wage is a type of price floor. Effects of minimum wage on above mentioned dimensions.

  • Minimum wage creates surplus of labour, leading to unemployment.
  • People who may have be willing to work at lesser wage are now unable to find jobs as employers can not pay minimum wage.

Minimum wage affects

  • Only small % of workers are paid at minimum wage, less than 5%.
  • Large increase in the minimum wage will cause serious increase in unemployment.

Test case

  • US government accidentally increased minimum wage in Puerto Rico, by a lot.
  • Led to many businesses shutting down and a very high increase in unemployment.

Communism = universal price controls.