Price+ceiling

By Aaron Ford
 * Price Ceilings**


 * Price ceilings** are a government imposed limit on what suppliers can charge for a good or service within a market. In order for a price ceiling to be effective, it must be set below the **market equilibrium**. (Baye) In the article, "Price Ceilings Cause Shortages and Higher Prices, economist, Dwight Lee states, "once government goes beyond protecting voluntary exchange as an impartial referee and attempts to determine particular outcomes, it disrupts the social cooperation that is the surest means to generally desirable outcomes." What Dwight means by this is, if government interferes with the free trade of a market it can lead to resources not being used at their most valued uses, thus leading to disgruntled suppliers and buyers. For a more in-depth understanding of the effects of price ceilings and an understanding of why governments impose them, please continue reading.

The best way to understand economics is through examples. Without further ado, below is an example of what a market looks like when placed under a price ceiling, which I conveniently borrowed from college-cram.com. In the image you’ll notice that the market is in equilibrium when the price of the good is $5.00 and the quantity supplied is also 5.

If the price ceiling were set at any amount above $5.00, the price ceiling would have no effect on suppliers and buyers because the market would naturally gravitate towards the equilibrium point. (Baye) If the government feels that the uncontrolled market price of $5.00 is too high, it can place a limit on the amount that a supplier can charge for its good. Is this limit (ceiling) good for the buyers and sellers? This question has more than one answer. Given the graph above,the price ceiling is $2.00 and the quantity supplied and demanded at that price are two and eight, respectively.

If you are a supplier and your product costs are $2.00 or less (meaning your product is one of the two being sold) then you would feel that the price ceiling is good because the demand for your product far exceeds what you are able to produce for profit. If you are a buyer and you happen to be one of the two that was able to receive a good, then you also believe the ceiling is good. Those are the good outcomes with regard for the above question, but what about the bad outcomes?


 * Shortages** are an inevitable outcome of price ceilings. (Deardorff) If you are a supplier and your product costs are greater than $2.00, but less than $5.00 (supplied quantities between two and five) you are unable to sell your product for a profit at a price a buyer would find to be less than their holdout price had the market been uncontrolled. This inability to buy because sellers are not willing to sell at the ceiling price accounts for half of the shortage caused from price ceilings. The other half of the shortage from price ceilings is the increase in quantity demanded of those who are now willing to purchase the product at the lower mandated price. In order to try and contend with shortage in the market, suppliers may lower the quality of the goods being offered and thus lower their seller costs to keep them in the market.

With greater demand than supply, how are products designated to potential buyers? The most common legal method for allocating the products is on a "**first come, first served**" basis. This has the potential to create monstrously long queues of those individuals whose opportunity costs of waiting in line are lower than the costs of not waiting in line. Queues can be seen rather frequently in larger cities on opening days for blockbuster movies, such as the opening for a new George Lucas or Steven Spielberg film. These lines form because the customers know that the theater will sell the tickets at a set price (ceiling), and that at that price, demand for the tickets will exceed the number of seats available to view the film.

The **full economic price** of the movie tickets mentioned above is more than just the $5.00 paid for admission, there is also the cost of time. Waiting in line may not be an issue for those who believe their opportunity cost of time is very miniscule. However, there are individuals who are willing to pay monetarily more for a ticket, however are unable to wait in line because the opportunity cost of waiting in line could be equal to or greater than the cost of not waiting in line. With all of this in mind, the full economic price of the ticket is not only the price of admission but also the cost of time, waiting in the queue to purchase a ticket. The cost of time is an **opportunity cost**, also referred to as a **nonpecuniary cost**.

Another legal method for designating who is to receive the limited goods is to create a **lottery**, whereby participants can add their name to a list for random draw. (Fundamentalfinance.com) While both of the above methods work for products that are wants of consumers, what happens in the case of products that are a need of consumers. One such answer is all the lines you see of individuals waiting on a soup-kitchen to open so that the consumers can eat. While this line doesn't seem to be a problem for those who do not have money or anything else to lose, what are the circumstances for those that do have money and do have something to lose? In extreme cases, a **black market** can develop in which secret transactions take place between the "haves" and the "have-nots." Historically, these goods are generally sold at prices much higher than the equilibrium price had the market not had a price control to begin with.

With all of these negative outcomes of price ceilings, you might ask yourself why the government would mandate such restrictions. According to economist Hugh Rockoff, "even though they (price ceilings) fail to protect many consumers and hurt others, controls hold out the promise of protecting groups of consumers who are particularly hardpressed to meet price increases."

Overall economists believe that resources should go to the highest valued use. A question to ponder; in a constantly flowing market, how does one (the government, suppliers, buyers, etc.) determine the highest valued use?

Price Ceiling Questions: 1. If the government places a price floor on a good that is above the equilibrium price_ a.) a shortage will occur b.) demand will change c.) none of the above

Answer: c.) none of the above - //a price ceiling will be ineffective if placed above market equilibrium, in other words no shortage and no change in demand.//

2. If the government places a price ceiling on a good below the equilibrium price a.) a shortage will occur b.) demand will change c.) none of the above

Answer: a.) a shortage will occur //- more buyers are willing to pay the lower price, however more suppliers are not willing to sell at the lower price.//

3. Market price + = full economic price a.) shortage b.) surplus c.) nonpecuniary costs d.) production costs

Answer: c.) nonpecuniary costs //- the full economic price of something is not only the market price for the product, but also what you give up by not using the funds on something else in addition to the cost of time spent in order to make the purchase.//

4. Which of the following is not a legal method of allocating scarce goods: a.) lottery b.) black market c.) first come, first served

Answer: b.) black market //- the black market is a market in which scarce goods are sold above a government mandated price ceiling and often times above market equilibrium//

5. If you are a seller in a market and your government places a price ceiling on the market of $8.00 for your good, which of the following additional information is needed to determine whether or not you should sell your product on the market? I. seller's costs II. quantity demanded at a market price of $8.00 III. market equilibrium price

a.) I only b.) I and II only c.) I and III only d.) II and III only

Answer: c) I and III only - By knowing the market equilibrium price and seller's cost you will know whether or not you can make a profit by selling at the price ceiling. If the price ceiling is above equilibrium, you will still need to know market equilibrium price to know if participating in the market is profitable. If the price ceiling is lower than the equilibrium price but still higher than your selling costs, you will know that it is profitable to participate in the market.

References:

Baye, Michael R., //"Managerial Economics and Business Strategy"//, McGraw-Hill Irwin. 2006.

Deardorff, Alan V., "Deardorff's Glossary of International Economics" Last Revision September 19, 2007. Accessed on September 19, 2007. http://www-personal.umich.edu/~alandear/glossary/p.html.

//"Government Intervention". College-cram.com. September 17, 2007. http://www.college-cram.com/study/economics/presentations/634//

Lee, Dwight R.,// "Price Ceilings Cause Shortages and Higher Costs." //The Freeman: Ideas on Liberty.// Vol 48 No 11. November 1998. Accessed on September 19, 2007. http://www.fee.org/publications/the-freeman/article.asp?aid=3746

"Price Ceilings". FundamentalFinance.com. Accessed on September 17, 2007. http://economics.fundamentalfinance.com/price-ceiling.php

Rockoff, Hugh, "Price Controls" //The Library of Economics and Liberty.// Accessed on September 19, 2007. http://www.econlib.org/LIBRARY/Enc/PriceControls.html