Price Ceiling and Price Floors

1. Economic Efficiency,
Price Ceilings and Price Floors

2. Efficiency and Equity (c)
Andrew Tibbitt 2008 Slide 2
Equity – how fair is the distribution of products between different
members of society?
1. Horizontal equity – no discrimination between people whose
economic characteristics and performance are equal
(provide everybody with the same opportunity to succeed and
earn a high income)
1. Vertical equity – different treatment of different people in
order to reduce the differences between people (Robin Hood
approach)
2. those who are more able to pay taxes should contribute more
than those who are not

3. 3
 Understand what happens to economic efficiency
when a market is not in competitive equilibrium.
Objectives:

4. 4
 Understand what happens to economic efficiency
when a market is not in competitive equilibrium.
 Use demand and supply graphs to analyze the
economic impact of a price ceiling.
Objectives:

5. 5
 Understand what happens to economic efficiency
when a market is not in competitive equilibrium.
 Use demand and supply graphs to analyze the
economic impact of a price ceiling.
 Use demand and supply graphs to analyze the
economic impact of a price floor.
Objectives:

6. 6
Objective 1
Understand what happens to economic efficiency when a
market is not in competitive equilibrium.

7. 7
Objective 1
 Economic surplus is maximized at equilibrium in a
perfectly competitive market. The term “competitive
markets” refer to “perfectly competitive markets”.
Understand what happens to economic efficiency when a
market is not in competitive equilibrium.

8. 8
Objective 1
 Economic surplus is maximized at equilibrium in a
perfectly competitive market. The term “competitive
markets” refer to “perfectly competitive markets”.
 A competitive equilibrium is allocatively efficient.
Understand what happens to economic efficiency when a
market is not in competitive equilibrium.

9. 9
 When a market is not in a competitive equilibrium,
there is an efficiency loss or a deadweight loss.
Objective 1: What happens to economic efficiency when a
market is not in competitive equilibrium.

10. 10
 When a market is not in a competitive equilibrium,
there is an efficiency loss or a deadweight loss.
 A deadweight loss is the reduction in economic
surplus resulting from a market not being in
competitive equilibrium.
Objective 1: What happens to economic efficiency when a
market is not in competitive equilibrium.

11. 11
 Although the total net benefit to society is
maximized at a competitive market equilibrium,
individual consumers would be better off if they
could pay a lower than equilibrium price and,
individual producers would be better off if they
could sell at a higher than equilibrium price.
Objective 1: What happens to economic
efficiency when a market is not in
competitive equilibrium.

12. 12
 Although the total net benefit to society is
maximized at a competitive market equilibrium,
individual consumers would be better off if they
could pay a lower than equilibrium price and,
individual producers would be better off if they
could sell at a higher than equilibrium price.
 Consumers and producers sometimes lobby the
government to legally require a market price
different from the equilibrium price.
Objective 1: What happens to economic
efficiency when a market is not in
competitive equilibrium.

13. 13
 Some examples of price controls imposed by the
government include rent control, agricultural price
supports, and minimum wage regulations.
Objective 1: What happens to economic
efficiency when a market is not in
competitive equilibrium.

14. 14
 Some examples of price controls imposed by the
government include rent control, agricultural price
supports, and minimum wage regulations.
 The government could also use quantity
interventions such as an output quota or a limit on
the maximum amount that can be produced.
Objective 1: What happens to economic
efficiency when a market is not in
competitive equilibrium.

15. 15
Example 1: Consider the coffee market. At the equilibrium
price of $3,
Objective 1:…economic efficiency in a
competitive equilibrium.
The competitive
equilibrium is
efficient. Economic
surplus is
maximized.

16. 16
Example 1: Consider the coffee market. At the equilibrium
price of $3,
Consumer surplus = A + B + C
Objective 1:…economic efficiency in a
competitive equilibrium.
The competitive
equilibrium is
efficient. Economic
surplus is
maximized.

17. 17
Example 1: Consider the coffee market. At the equilibrium
price of $3,
Consumer surplus = A + B + C
Producer surplus = D + E + F
Objective 1:…economic efficiency in a
competitive equilibrium.
The competitive
equilibrium is
efficient. Economic
surplus is
maximized.

18. 18
Example 1: Consider the coffee market. At the equilibrium
price of $3,
Consumer surplus = A + B + C
Producer surplus = D + E + F
Economic surplus = A + B + C + D + E + F
Objective 1:…economic efficiency in a
competitive equilibrium.
The competitive
equilibrium is
efficient. Economic
surplus is
maximized.

19. 19
Suppose the price is above equilibrium at $4,
Objective 1:…economic efficiency when a
market is not in a competitive equilibrium.
These trades do
not take place
resulting in an
economic surplus
loss

20. 20
Quantity traded = 300 cups of coffee
Suppose the price is above equilibrium at $4,
Objective 1:…economic efficiency when a
market is not in a competitive equilibrium.
These trades do
not take place
resulting in an
economic surplus
loss

21. 21
Quantity traded = 300 cups of coffee
Economic surplus loss = C + E.
Suppose the price is above equilibrium at $4,
Objective 1:…economic efficiency when a
market is not in a competitive equilibrium.
These trades do
not take place
resulting in an
economic surplus
loss

22. 22
Suppose the price is below equilibrium at $2,
Objective 1:…economic efficiency when a
market is not in a competitive equilibrium.
These trades do
not take place
resulting in an
economic surplus
loss

23. 23
Quantity traded = 300 cups of coffee
Suppose the price is below equilibrium at $2,
Objective 1:…economic efficiency when a
market is not in a competitive equilibrium.
These trades do
not take place
resulting in an
economic surplus
loss

24. 24
Quantity traded = 300 cups of coffee
Economic surplus loss = C + E.
Suppose the price is below equilibrium at $2,
Objective 1:…economic efficiency when a
market is not in a competitive equilibrium.
These trades do
not take place
resulting in an
economic surplus
loss

25. 25
At any price other than the competitive
equilibrium price, the marginal benefit of the last
unit sold is not equal to the marginal cost of the
last unit produced and the market outcome (which
means the price and quantity that will prevail in
the market) is not efficient.
Objective 1:…economic efficiency and a
competitive equilibrium.

26. 26
Objective 2
Use demand and supply graphs to analyze the
economic impact of a price ceiling.

27. 27
Objective 2
 A price ceiling is a legally determined maximum
price above which market price is not allowed to
rise.
Use demand and supply graphs to analyze the
economic impact of a price ceiling.

28. 28
Objective 2
 A price ceiling is a legally determined maximum
price above which market price is not allowed to
rise.
 Some examples include rent control, the price
ceiling on natural gas in the early 1960s, the
maximum price on petrol, and the maximum price
on pharmaceutical drugs
Use demand and supply graphs to analyze the
economic impact of a price ceiling.

29. 29
Objective 2
 A price ceiling is a legally determined maximum
price above which market price is not allowed to
rise.
 Some examples include rent control, the price
ceiling on natural gas in the early 1960s, the
maximum price on petrol, and the maximum price
on pharmaceutical drugs
 A binding price ceiling must lie below the free
market equilibrium price.
Use demand and supply graphs to analyze the
economic impact of a price ceiling.

30. 30
Example 2: Consider the market for rental apartments.
In the absence of any government intervention, the
equilibrium rent is $800.
Objective 2: .. the economic impact of a price ceiling.

31. 31
Example 2: Consider the market for rental apartments.
In the absence of any government intervention, the
equilibrium rent is $800. Suppose the government
imposes a rent ceiling at $600.
Objective 2: .. the economic impact of a price ceiling.

32. 32
Example 2: Consider the market for rental apartments.
In the absence of any government intervention, the
equilibrium rent is $800. Suppose the government
imposes a rent ceiling at $600.
The ceiling creates a persistent
shortage:
Qd = 350,000, Qs = 250,000
Shortage = Qd − Qs
=100,000 apartments
Objective 2: .. the economic impact of a price ceiling.

33. 33
Objective 2: .. the economic impact of a price ceiling.

34. 34
No government
intervention
With price
ceiling
Market price $800
Quantity Demanded
Quantity Supplied
Quantity Traded
Shortage
Consumer Surplus
Producer Surplus
Economic Surplus
Objective 2: .. the economic impact of a price ceiling.

35. 35
No government
intervention
With price
ceiling
Market price $800
Quantity Demanded 300,000
Quantity Supplied 300,000
Quantity Traded 300,000
Shortage 0
Consumer Surplus
Producer Surplus
Economic Surplus
Objective 2: .. the economic impact of a price ceiling.

36. 36
No government
intervention
With price
ceiling
Market price $800
Quantity Demanded 300,000
Quantity Supplied 300,000
Quantity Traded 300,000
Shortage 0
Consumer Surplus T+U+X
Producer Surplus
Economic Surplus
Objective 2: .. the economic impact of a price ceiling.

37. 37
No government
intervention
With price
ceiling
Market price $800
Quantity Demanded 300,000
Quantity Supplied 300,000
Quantity Traded 300,000
Shortage 0
Consumer Surplus T+U+X
Producer Surplus V+W+Y
Economic Surplus
Objective 2: .. the economic impact of a price ceiling.

38. 38
No government
intervention
With price
ceiling
Market price $800
Quantity Demanded 300,000
Quantity Supplied 300,000
Quantity Traded 300,000
Shortage 0
Consumer Surplus T+U+X
Producer Surplus V+W+Y
Economic Surplus T+U+W+V+X+Y
Objective 2: .. the economic impact of a price ceiling.

39. 39
No government
intervention
With price
ceiling
Market price $800 $600
Quantity Demanded 300,000
Quantity Supplied 300,000
Quantity Traded 250,000
Shortage 0
Consumer Surplus T+U+X
Producer Surplus V+W+Y
Economic Surplus T+U+X+V+W+Y
Objective 2: .. the economic impact of a price ceiling.

40. 40
No government
intervention
With price
ceiling
Market price $800 $600
Quantity Demanded 300,000 350,000
Quantity Supplied 300,000 250,000
Quantity Traded 250000 250,000
Shortage 0 100,000
Consumer Surplus T+U+X
Producer Surplus V+W+Y
Economic Surplus T+U+X+V+W+Y
Objective 2: .. the economic impact of a price ceiling.

41. 41
No government
intervention
With price
ceiling
Market price $800 $600
Quantity Demanded 300,000 350,000
Quantity Supplied 300,000 250,000
Quantity Traded 250000 250,000
Shortage 0 100,000
Consumer Surplus T+U+X T+U+V
Producer Surplus V+W+Y
Economic Surplus T+U+X+V+W+Y
Objective 2: .. the economic impact of a price ceiling.

42. 42
No government
intervention
With price
ceiling
Market price $800 $600
Quantity Demanded 300,000 350,000
Quantity Supplied 300,000 250,000
Quantity Traded 250000 250,000
Shortage 0 100,000
Consumer Surplus T+U+X T+U+V Gain: V-X
Producer Surplus V+W+Y
Economic Surplus T+U+X+V+W+Y
Objective 2: .. the economic impact of a price ceiling.

43. 43
No government
intervention
With price
ceiling
Market price $800 $600
Quantity Demanded 300,000 350,000
Quantity Supplied 300,000 250,000
Quantity Traded 250000 250,000
Shortage 0 100,000
Consumer Surplus T+U+X T+U+V Gain: V-X
Producer Surplus V+W+Y W
Economic Surplus T+U+X+V+W+Y
Objective 2: .. the economic impact of a price ceiling.

44. 44
No government
intervention
With price
ceiling
Market price $800 $600
Quantity Demanded 300,000 350,000
Quantity Supplied 300,000 250,000
Quantity Traded 250000 250,000
Shortage 0 100,000
Consumer Surplus T+U+X T+U+V Gain: V-X
Producer Surplus V+W+Y W Loss: V+Y
Economic Surplus T+U+X+V+W+Y
Objective 2: .. the economic impact of a price ceiling.

45. 45
No government
intervention
With price
ceiling
Market price $800 $600
Quantity Demanded 300,000 350,000
Quantity Supplied 300,000 250,000
Quantity Traded 300,000 250,000
Shortage 0 100,000
Consumer Surplus T+U+X T+U+V Gain: V-X
Producer Surplus V+W+Y W Loss: V+Y
Economic Surplus T+U+X+V+W+Y T+U+V+W
Objective 2: .. the economic impact of a price ceiling.

46. 46
No government
intervention
With price
ceiling
Market price $800 $600
Quantity Demanded 300,000 350,000
Quantity Supplied 300,000 250,000
Quantity Traded 300,000 250,000
Shortage 0 100,000
Consumer Surplus T+U+X T+U+V Loss: X
Producer Surplus V+W+Y W Loss: V+Y
Economic Surplus T+U+X+V+W+Y T+U+V+W DWL: X+Y
Objective 2: .. the economic impact of a price ceiling.

47. 47
Without rent control, 50,000 more apartments would be rented.
By not renting these 50,000 apartments, a deadweight loss
equal to (X+Y) is created.
Objective 2: .. the economic impact of a price ceiling.

48. 48
Without rent control, 50,000 more apartments would be rented.
By not renting these 50,000 apartments, a deadweight loss
equal to (X+Y) is created.
For the last unit traded, marginal benefit is greater than marginal cost.
Objective 2: .. the economic impact of a price ceiling.

49. 49
 Rent control creates a persistent shortage of 50,000
apartments.
Objective 2: .. the economic impact of a price ceiling.

50. 50
 The rent control creates a persistent shortage of 50,000
apartments.
 Are there beneficiaries? Yes, those who are able to rent
apartments now pay $600 instead of $800.
Objective 2: .. the economic impact of a price ceiling.

51. 51
 The rent control creates a persistent shortage of 50,000
apartments.
 Are there beneficiaries? Yes, those who are able to rent
apartments now pay $600 instead of $800.
 Some producer surplus (the area V) has been transferred
to consumers.
Objective 2: .. the economic impact of a price ceiling.

52. 52
Objective 3
Use demand and supply graphs to analyze the
economic impact of a price floor.

53. 53
Objective 3
 A price floor is a legally determined minimum price that
sellers may receive for a product. The market price
cannot fall below this price.
Use demand and supply graphs to analyze the
economic impact of a price floor.

54. 54
Objective 3
 A price floor is a legally determined minimum price that
sellers may receive for a product. The market price
cannot fall below this price.
 Some examples include agricultural price supports,
dairy price supports, and minimum wage regulations.
Use demand and supply graphs to analyze the
economic impact of a price floor.

55. 55
Objective 3
 A price floor is a legally determined minimum price that
sellers may receive for a product. The market price
cannot fall below this price.
 Some examples include agricultural price supports,
dairy price supports and minimum wage regulations.
 A binding price floor must lie below the free market
equilibrium price.
Use demand and supply graphs to analyze the
economic impact of a price floor.

56. 56
Example 3: Consider the milk market. In the absence of
any government intervention, the equilibrium price is $2.00.
Objective 3: .. the economic impact of a price floor.

57. 57
Example 3: Consider the milk market. In the absence of
any government intervention, the equilibrium price is $2.00.
Now the government imposes a price floor at $2.50 to help
dairy farmers.
Objective 3: .. the economic impact of a price floor.

58. 58
Example 3: Consider the milk market. In the absence of
any government intervention, the equilibrium price is $2.00.
Now the government imposes a price floor at $ 2.50 to help
dairy farmers.
The price floor creates a
persistent surplus:
Qs = 650,000, Qd = 300,000
Surplus = Q4 − Qd
= 350,000 gallons.
Objective 3: .. the economic impact of a price floor.

59. 59
Objective 3: .. the economic impact of a price floor.

60. 60
No government
intervention
With price
floor
Market price $2.00
Quantity Demanded
Quantity Supplied
Quantity Traded
Surplus
Consumer Surplus
Producer Surplus
Economic Surplus
Objective 3: .. the economic impact of a price floor.

61. 61
No government
intervention
With price
floor
Market price $2.00
Quantity Demanded 500,000 litres
Quantity Supplied 500,000 litres
Quantity Traded 500,000 litres
Surplus 0
Consumer Surplus
Producer Surplus
Economic Surplus
Objective 3: .. the economic impact of a price floor.

62. 62
No government
intervention
With price
floor
Market price $2.00
Quantity Demanded 500,000 litres
Quantity Supplied 500,000 litres
Quantity Traded 500,000 litres
Surplus 0
Consumer Surplus A+B+D
Producer Surplus
Economic Surplus
Objective 3: .. the economic impact of a price floor.

63. 63
No government
intervention
With price
floor
Market price $2.00
Quantity Demanded 500,000 litres
Quantity Supplied 500,000 litres
Quantity Traded 500,000 litres
Surplus 0
Consumer Surplus A+B+D
Producer Surplus C+E
Economic Surplus
Objective 3: .. the economic impact of a price floor.

64. 64
No government
intervention
With price
floor
Market price $2.00
Quantity Demanded 500,000 litres
Quantity Supplied 500,000 litres
Quantity Traded 500,000 litres
Surplus 0
Consumer Surplus A+B+D
Producer Surplus C+E
Economic Surplus A+B+C+D+E
Objective 3: .. the economic impact of a price floor.

65. 65
No government
intervention
With price
floor
Market price $2.00 $2.50
Quantity Demanded 500,000 litres
Quantity Supplied 500,000 litres
Quantity Traded 500,000 litres
Surplus 0
Consumer Surplus A+B+D
Producer Surplus C+E
Economic Surplus A+B+C+D+E
Objective 3: .. the economic impact of a price floor.

66. 66
No government
intervention
With price
floor
Market price $2.00 $2.50
Quantity Demanded 500,000 litres 300,000 litres
Quantity Supplied 500,000 litres 650,000 litres
Quantity Traded 500,000 litres 300,000 litres
Surplus 0 350,000 litres
Consumer Surplus A+B+D
Producer Surplus C+E
Economic Surplus A+B+C+D+E
Objective 3: .. the economic impact of a price floor.

67. 67
No government
intervention
With price
floor
Market price $2.00 $2.50
Quantity Demanded 500,000 litres 300,000 litres
Quantity Supplied 500,000 litres 650,000 litres
Quantity Traded 500,000 litres 300,000 litres
Surplus 0 350,000 litres
Consumer Surplus A+B+D A
Producer Surplus C+E
Economic Surplus A+B+C+D+E
Objective 3: .. the economic impact of a price floor.

68. 68
No government
intervention
With price
floor
Market price $2.00 $2.50
Quantity Demanded 500,000 litres 300,000 litres
Quantity Supplied 500,000 litres 650,000 litres
Quantity Traded 500,000 litres 300,000 litres
Surplus 0 350,000 litres
Consumer Surplus A+B+D A Loss: B+D
Producer Surplus C+E
Economic Surplus A+B+C+D+E
Objective 3: .. the economic impact of a price floor.

69. 69
No government
intervention
With price
floor
Market price $2.00 $2.50
Quantity Demanded 500,000 litres 300,000 litres
Quantity Supplied 500,000 litres 650,000 litres
Quantity Traded 500,000 litres 300,000 litres
Surplus 0 350,000 litres
Consumer Surplus A+B+D A Loss: B+D
Producer Surplus C+E B+C
Economic Surplus A+B+C+D+E
Objective 3: .. the economic impact of a price floor.

70. 70
No government
intervention
With price
floor
Market price $2.00 $2.50
Quantity Demanded 500,000 litres 300,000 litres
Quantity Supplied 500,000 litres 650,000 litres
Quantity Traded 500,000 litres 300,000 litres
Surplus 0 350,000 litres
Consumer Surplus A+B+D A Loss: B+D
Producer Surplus C+E B+C Gain: BE
Economic Surplus A+B+C+D+E
Objective 3: .. the economic impact of a price floor.

71. 71
No government
intervention
With price
floor
Market price $2.00 $2.50
Quantity Demanded 500,000 litres 300,000 litres
Quantity Supplied 500,000 litres 650,000 litres
Quantity Traded 500,000 litres 300,000 litres
Surplus 0 350,000 litres
Consumer Surplus A+B+D A Loss: B+D
Producer Surplus C+E B+C Gain: BE
Economic Surplus A+B+C+D+E A+B+C
Objective 3: .. the economic impact of a price floor.

72. 72
No government
intervention
With price
floor
Market price $2.00 $2.50
Quantity Demanded 500,000 litres 300,000 litres
Quantity Supplied 500,000 litres 650,000 litres
Quantity Traded 500,000 litres 300,000 litres
Surplus 0 350,000 litres
Consumer Surplus A+B+D A Loss: B+D
Producer Surplus C+E B+C Gain: B
Economic Surplus A+B+C+D+E A+B+C DWL: D+E
Objective 3: .. the economic impact of a price floor.

73. 73
 Without a price floor, 200,000 more litres of milk would
be consumed. By not selling these 200,000 litres, a
deadweight loss equal to (D+E) is created.
Objective 3: .. the economic impact of a price floor.

74. 74
 Without a price floor, 200,000 more litres of milk would
be consumed. By not selling these 200,000 litres, a
deadweight loss equal to (D+E) is created.
 For the last unit purchased, marginal benefit exceeds marginal cost.
Objective 3: .. the economic impact of a price floor.

75. 75
Price ceilings and price floors:
 reduce the economic total surplus.
Key Points

76. 76
Price ceilings and price floors:
 reduce the economic total surplus.
 create a deadweight loss.
Key Points

77. 77
Price ceilings and price floors:
 reduce the economic total surplus.
 create a deadweight loss.
 redistribute some surplus from producers to
consumers in the case of a price ceiling.
Key Points

78. 78
Price ceilings and price floors:
 reduce the economic total surplus.
 create a deadweight loss.
 redistribute some surplus from producers to
consumers in the case of a price ceiling.
 redistribute some surplus from consumers to
producers to in the case of a price floor.
Key Points

79. 79
Price ceilings and price floors:
 reduce the economic total surplus.
 create a deadweight loss.
 redistributes some surplus from producers to
consumers in the case of a price ceiling.
 redistributes some surplus from consumers to
producers to in the case of a price floor.
 reduce the quantity traded.
Key Points

80.  alter the value of resources and lead to a
misallocation of resources.
22

81.  alter the value of resources and lead to a
misallocation of resources.
 create a market outcome that is inefficient.
22

82. While price ceilings and price floors reduce
economic efficiency, often they are justified on
equity grounds. For example, consider the
arguments in favor of rent control and minimum
wage regulations.
 alter the value of resources and lead to a
misallocation of resources.
 create a market outcome that is inefficient.
22