Lolli’s Lecture: Price Control. A government steps into a marketplace and interferes with a free market. The expectations is that as we do these modules, that you are reading the modules on our own because it is impossible for me to lecture on every single word in the textbook. I show you the things that you need to know and are on the test, but textbook deepens the material. When I teach supply and demand, I don’t spend a lot of time explaining competitive market, because we will get to market structure, and there are three markets. When I hit that module, I will explain competitive market. There are points in the module that talk about competitive market. There are so many buyers and sellers, no buyer and seller have any real power. When the market is left to the forces of supply and demand, this is the most efficient a market can be. It is introduced in the first chapter as the “invisible hand”, governments don’t need to be involved for it to be efficient, just let people and supply and demand dictate. If you let these forces determine, you will end up with the most sufficient market. We talk about how if the store sets a price too high, they will have more stuff, and price will go down. We talk about Dunkin, you make a 1000 donuts, you sold out by noon and you sell more the next day. Those are the adjustments of the competitive market, and a government will not come out and say “You have to sell more donuts.” The seller must dictate the price by themselves. The reason I bring that up today because we are now going to study what is called price controls. Which means the government is stepping in and dictate prices on certain goods and serves. We have to look at price floors (ABOVE) and price ceilings (BELOW). Now, I wrote next to those things below and above, and the easiest way to remember is that it doesn’t make sense. If I ask you to look at the floor, hopefully you would all look down but of course in microeconomics, a price floor is above the equilibrium, and a ceiling is below it. In micro, the world is upside down. They are called floors and ceilings because they minimum and maximum. The floor is minimum, and the maximum is the ceiling. You can’t go below the floor and you can’t go above the ceiling. So the government will create floors and ceilings when they feel that there is a fundamental failure in the marketplace. If they feel that the laws of supply and demand fail, the government will “fix it.” The government “fixing it” creates more problems. So when we talked the first module, about capitalism and, um, command economies. Right, we talked about market economics and command economics? We talked about those are two extremes. Command is equate to communism. Market economy is not government intervention at all. If we had more time to talk about, I would talk about wha the US is. US is a mixed economy, it is closer to market than command, but our governments put their fingers and hands into the economy. Taxes are also a way for government to get involved in the economy. There is no such market that has a true market economy. These are two examples: Legal Minimum Price and Legal Price Maximum. A price floor, because it is a minimum price, in order for it be effective it must be above the equilibrium. So let’s attach some prices, some actual numbers, to these things. And we will even put some numbers to the quantity. So in this marketplace, the laws of supply and demand dictate a price of $5 and a 1000 units sold, that is with no government intervention. For some reason, the government deem that a market failure, so they step in and save, $5 is too low of a price in this marketplace, we are going to set the legal minimum at $10. No producer is allowed to sell it for less than $10. But $5 and $7 is no longer an option. When the government does this, the quantity demanded is now smaller than it was. Hopefully, when we discuss equilibrium, you understand that this Q simultaneously represents D and S. It represents quantity supplied simultaneously. With this new price, however, the quantity demanded is now 500 units, and the quantity supplied at 1500 units. What happens when the quantity supplied exceeds the quantity demanded? There is a surplus, there’s too much. You end up with extra product that does not sell. Because the government has set this artificial price, the market is now out of equilibrium. When producers hear that they are going to get $10 for this product instead of $5, they are willing to be produce more. When buyers hear they have to pay $10, there are less people that wants to purchase it. So when I ask you how many surplus are there going to be at a prince of $10, there is a 1000 units (1500 produced-500 purchased). So before we get into more, let’s talk about why the government would think that this is a failure. The only thing I said in the beginning was that the $5 was too low of a price, so the government set a minimum price. Okay, so the government thinks it is too low. These are private markets, whatever this product is, there are private companies producing it and attempting to profit from it. Individual human beings deciding to buy it or not buy it, no one is forced, everyone is acting in their best interest. The government says it’s bad. Sometimes there are goods and services that, well, all need, to economy, livelihood, survival, and these products exist in just private markets. If that market experiences a failure where there is so much competitive, that the price gets pushed down so low, the producer of this good can no longer profit and go out of businesses, this is bad for economy. There are places in the US, where homes have no drinking water. If you read the news, as recent as last year, Michigan homes have contaminated water. Other countries don’t have clean fresh drinking water. There are people that have to buy bottled water, just to have clean drinking water. If that marketplace became so competitive that at $5 a case, bottled water companies are not profitable and will go out of businesses. Do you understand why this is bad for all of us? It is bad for all of us as a society. Because it became so competitive and prices went so low, these companies don’t make a profit. Why won’t charging a higher price work? It might be too high of a price for buyers. So in a competitive market where you have options, that’s what a competitive market is. I can buy all different bottled waters I want. The company that needs to charge $7 can’t because somebody else is doing it for $5. In a competitive market place, you don’t have control of the price, it is set by supply and demand. They can’t just charge a higher price because they will lose out of competition. The government will deem this as a market failure. They can’t compete with each other and a minimum price is set, they will all stay in businesses. The new problem is that people cannot afford $10. We now have a surplus. We have 1500 producers, and only 500 people buying it. We have a 1000 units of bottled water going unsold. When that happens, the government must purchase all surplus. The government recognized the problem and they “fixed it” by putting a price floor on it, and by fixing it they created a new problem, which is a surplus. Now to fix that problem, they have to purchase all of the surplus. They will have to buy 1000 surplus cases for $10. They buy it through our taxes. Now instead of paying $10 instead of $5, we have to raise taxes to buy surplus. Ideally, the government will give it to families who need the water. Now you’re going fund these people by giving them free drinking water. There is good in this, but sometimes to fix a problem, you need to spend money. Again, we are not a market economy, we are taking money to taxpayers and redistributing it to people who need help. Market economy is not a kind economy, it doesn’t help people. In this case, they are helping producers and hurting buyers. Your textbook calls that winners and losers because you have to be tested and a very common question is who wins and loses from price floors. Buyers lose, sellers win. Saif's question “Does the government only step in critical marketplaces?” The answer is yes and no. The only reason to get involved if all of society need the goods. They also get involved if something is dangerous. We have high taxes on marijuanas, alcohol. The government want to punish people who purchase it by putting a high price on it. It is critical to society to prevent caner and drunk driving and things like that. So that is a price floor. In a price floor the quantity supplied exceeds quantity demanded. I told you it must be above the equilibrium. The term that is used to describe price floor that is above equilibrium is called binding. It is just a term used to say that this price floor indicates the market. If school lunch $5 everyday and then Gov Murphy says school lunch cannot be less than $10. Chartwell will have to charge $10. What if Gov Murphys ays a new price floor on lunch is $2. What is Chartwell going to charge? $5. Did a price floor below the equilibrium do anything? No. Now you understand why a price floor has to be above the equilibrium in order to be binding. If it was down, it would be non binding. If Gov Murphys says less than $2 is not allowed, it wouldn’t impact any schools, because no schools are charging $2 for lunch. The last thing to do about this is the math that we need to know for the test. How do you calculate total revenue? If I asked you for total revenue, it is price times quantity. Before the price floor, what was the total revenue? It was 5000 (1000 times 5). When the price floor is instituted before the government buys the surplus 5000 (10 times 500). Price times quantity demanded. It doesn’t matter how many are produced, if they are not sold, there is no revenue. Now the government purchases all of the surplus. What is the total revenue now? 15000 (10 times 1500). All 1500 will be sold at a price of $10. Alright, price ceilings now. So a price ceiling is a price maximum, you cannot charge more than the ceiling. It is set below the equilibrium in order for it to be binding. A price ceiling is used to help buyer and hurt seller. Again, our winner is buyers and the loser is sellers. Because if you are a seller and you were selling it for $4, you were happy and the government says $2, and if you’re a buyer getting at a half price, they’re happy. In order for the government to protect buyers, can it be something we don’t need? It needs to be something critical If it is bottled water and people can’t afford at $4, the government is going to lower the price. Quantity demanded at the ceiling is greater than quantity supplied which results in a shortage. At $3 everybody wants it, but sellers are not going to produce it. With the floor, we have a surplus. For the ceiling, there is a shortage. They are going to use tax dollars to fix this one too, but what are they going to do? A government subsidy. A government is going to throw money at the sellers, give money to the water bottled company. Make a bunch of water bottle and sell at $2, for every bottle you lose, we will send you $2. Now they are going to make $4. The money comes from our taxes, our taxes go up. If the government wants them to produce 750 instead of 500, more water. The government will have to give them more money. Depending on what the government is trying to accomplish, if they want 500 units they have to send $2 subsidy. If 750 units, they have to send $4 subsidy. More water, higher taxes. What is this price ceiling called because it impacted the market? Binding. If I put the price ceiling up, it is called non-binding. The test questions is based on before the government fixes the problem they created. It will never be after the subsidy, or after they purchase the surplus. Okay, that is everything in Module 8. There is no test on 8 or 9. In future tests, 5, 6, 7 is deeply entrenched din the test. The next test will have all of it. Tests will have new material will have TRIBE and IRENT and ceilings and floors. If you want to get ahead, the next chapter is 46. Everything in between is macro.

Main Points

• Price Control is when a government steps into a marketplace and interferes with a free market.

  • A free market is an economic market with no government interference. No country in the world has this system.

• The government will create floors and ceilings when they feel that there is a fundamental failure in the marketplace. If they feel that the laws of supply and demand fail, the government will “fix it.” This usually creates more problems.

• Price Floors = Minimum

  • The government will set a minimum price and the price must never dip below the minimum

• Price Ceilings = Maximum

  • The government will set a maximum price and the price must never rise above the maximum

• When there is a price floor, the quantity supplied exceeds the quantity demanded. This leads to a surplus and there’s too much.

  • The government will buy the surplus to give to those who need the product and taxes will go up.

• When there is a price ceiling, the quantity demanded exceeds the quantity supplied. This leads to a shortage and there’s too little.

  • The government will give out subsidies to make up for the money lost for the sellers. Taxes will go up.

• A price floor that is above equilibrium and a price ceiling that is below equilibrium is binding.

• A price floor that is below equilibrium and a price ceiling that is above equilibrium is non-binding.