All goods and services are subject to scarcity at some level. Scarcity means that society must develop some allocation mechanism – rules to determine who gets what. Over recorded history, these allocation rules were usually command based – the king or the emperor would decide. In contemporary times, most countries have turned to market based allocation systems. In markets, prices act as rationing devices, encouraging or discouraging production and encouraging or discouraging consumption in such a way as to find an equilibrium allocation of resources. We will construct demand curves to capture consumer behavior and supply curves to capture producer behavior. The resulting equilibrium price “rations” the scarce commodity. Markets are frequent targets of government intervention. This intervention can be direct control of prices or it could be indirect price pressure through the imposition of taxes or subsidies. Both forms of intervention are impacted by elasticity of demand. After this course, you will be able to: • Describe consumer behavior as captured by the demand curve. • Describe producer behavior as captured by the supply curve. • Explain equilibrium in a market. • Explain the impact of taxes and price controls on market equilibrium. • Explain elasticity of demand. • Describe cost theory and how firms optimize given the constraints of their own costs and an exogenously given price. This course is part of the iMBA offered by the University of Illinois, a flexible, fully-accredited online MBA at an incredibly competitive price. For more information, please see the Resource page in this course and onlinemba.illinois.edu.
2-1.4. Direct Price Controls: Price Ceilings
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Из курса от партнера University of Illinois at Urbana-Champaign
Firm Level Economics: Consumer and Producer Behavior
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University of Illinois at Urbana-Champaign
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Курс 1 из 7 — Specialization Managerial Economics and Business Analysis
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Module 2: Government Intervention in Markets
Markets are frequent targets of governments. This module will introduce government policy intervention into the market. This intervention can be direct control of prices or it could be indirect price pressure through the imposition of taxes or subsidies. Both forms of intervention are impacted by elasticity.
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Larry DeBrockDean Emeritus and Professor of Finance and Professor of Economics
University of Illinois, Urbana-Champaign College of Business Department of Business Administration
Continuing along with our investigation into
direct price controls by the government we looked at price floors.
Price floors are prices that the government doesn't allow the market
to find a price lower than that.
Now we wanna think about the opposite of that, something called a price ceiling,
that is, prices are not permitted to go above that level.
Examples of price ceilings, oh every now and then the government
would intervene and put a price on, lets say prices just cant go above this level.
Some metropolitan areas, some states have regulations that
following a traumatic catastrophe event, like for
example a hurricane, that suppliers are not allowed to raise the price of
some needed commodities like milk, or ice, or chainsaws after these events.
So there are certain times that the government will just
put a maximum price and say that's it.
Probably the one that is the strongest example over the history of
the United States has been something called rent control.
So let's think about rent controls as examples of price ceilings.
We'll draw our axis system.
And on the vertical axis, we're going to measure price, which in this case is rent.
And on the horizontal axis, we're gonna measure quantity,
which in this case is the quantity of apartments for rent.
We'll draw an original supply that looks something like this.
And an original demand that looks something like this.
And that gives us a market clearing price.
We'll label as P0, Q0.
That's the price that the free market would find if left to its own devices.
Now sometimes that price is deemed to be too high.
So we'll take an example of rent control.
Sometimes the city municipal authority will look at rents and say,
these rents are out of line with what the typical person can afford.
If you're wealthy, you can afford it.
But monthly rents in midtown Manhattan can get in the several thousand dollar range.
Now, some people might say, well, it's just not possible for
the normal family to live there.
And now and then, city councils will say, well, what we ought to do
is let's just say a reasonable number of something less then that.
So, suppose they come along and say we have a price ceiling
that can't go above this level.
So one example for example might be that the prices in Manhattan where
$3500 a month, the city council might say well, for
this building, it's gonna be $800 a month.
They control these prices.
That's not exactly how it works, typically they'll announce a price,
they'll announce a time and say this building is rent controlled and
they'll quote the price at the current price.
And then as going forward, as the demand continues to grow,
the clearing price would be going above what that is.
That's an out of equilibrium situation.
We'll do it with this picture to understand how that out of equilibrium
situation looks.
When you get to a situation where the amount that consumers wish to purchase,
we'll call this x.
The amount of apartments actually in the market we'll call y.
You'll say, wait a minute Larry, the apartments were there.
How could this happen?
Well, what happens over time is that the landlord is willing,
in fact to put Q0 units out, if it can get this rent.
But if the rent is some cap level lower,
the landlord just doesn't, sometimes they just don't repair certain units.
If the unit's plumbing goes out or the unit has electricity problems,
or the unit has some structural problem, they just won't repair it.
And so what happens over time is there is just less of these units available because
no one's putting the effort into it anymore given this lower price.
And so as a result, you get the situation where there's a lot of people who want
the product, we'll call that x, and not very many of the units available.
Maybe you're even just giving part of your apartments to your relatives and say,
well at this price I can't get anymore for it, at least I'll let my son or
daughter live here or something like that.
Anyway you look at it this is an out of equilibrium situation.
There is too much of quantity demanded and not enough quantity supplied.
So how do we go about solving this problem?
Well it's a difficult issue.
The market is not allowed to decide who gets what.
We started our entire adventure in thinking about economics by thinking about
the fact that there's scarcity to there's just not enough to go around.
In this case, the price ceiling has created an artificial scarcity.
People want a lot more of the apartments than there are apartments to go around.
Normally, price would float up to that P0, and the market would be cleared.
In this case, it's not allowed for that to happen, so
you see that there's not going to be very many units put on the market.
At this amount the landlords could actually, if they could get away with it,
charge a really high price.
Okay. At that amount,
enough people willing to pay this amount, but
they can't, because they can't get any price higher than the price ceiling.
So how does this process work?
Who makes the allocation decision?
Well, unfortunately, the allocation decision is made by, essentially,
non-market forces.
And so it's not uncommon in some cities in America
to drive by a long line of people out on a sidewalk in the morning.
And you ask what's happening here?
And your friend who you were lucky to be staying with for a few days was somebody
in say San Francisco will say, well that's a rent controlled neighborhood.
Somebody must have died.
And the idea is that now somebody is gonna, there is gnna be a lot of
people who are going to interview for this particular apartment.
And you can imagine those interview process.
Those people would say look if I can get this apartment for only $600 a month rent
whereas the market clearing price is $3000 you know wow.
Make sure I'll call the landlord up and
say hey how about if I put hardwood floors in?
Or how about if I put a granite countertop in, or the landowner's not gonna
do it because he or she is now subject to the binding constraint of this low price.
But if the landlord picks the tenant correctly,
which may be someone who has a lot of wealth to begin with.
They can actually end up subsidizing these people.
The people will put a lot of their own cash into making sure
the apartment stays up to code.
And, in fact, is better than code with granite and hardwood and things like that,
which you wouldn't have had otherwise.
And again, it sort of defeats the purpose of what the city was all about
to begin with.
The city's goal was to make the apartment cheap enough that people of all sorts
of income levels, that a great diversity and population could come in to this area.
But the end result is by driving down the availability of the units,
you let someone else make the allocation decision.
And that allocation decision based on economics would be,
well I'm gonna put people in there who have the most ability to actually fix
the apartment up and take care of it.
Probably not the same outcome that the city wanted.
This is a tough problem.
People always try to figure out how to handle this problem that there's
prices are too high.
Many cities try different approaches.
Some cities that go out by just building lots of housing units for
people who have a certain level of income below a level.
Well, you can live in these housing areas.
Turns out those are not the most successful,
those are not the most successful outcomes.
It's a way to try to attack the problem by the government,
instead of just trying to restrict price, they might try to grow the supply.
But without letting the market intervene so that we can get some movement in and
out of these populations, the outcome is usually not very good.
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