EC4101 Week 06 Lecture 1 PDF

EC4101 Wk.06 Lec.01 Why Governments Control Prices: The market price moves to an equilibrium price, but it does not please either buyers or sellers. The government then intervenes to regulate prices by imposing price controls (legal restrictions on how high/low a market price may go). Interferenc...

EC4101 Wk.06 Lec.01 Why Governments Control Prices: The market price moves to an equilibrium price, but it does not please either buyers or sellers. The government then intervenes to regulate prices by imposing price controls (legal restrictions on how high/low a market price may go). Interference in markets leads to distorted price signals which cause resources to be misallocated, and they cannot give good information to buyers and sellers. Price Ceiling: The maximum price sellers are allowed to charge for a good/service. It must be below equilibrium price to be binding. Typically introduced during crises as they often lead to sudden increases. They lead to shortages as demand rises and supply falls. E.g. rent control in NY. How Ceilings cause Inefficiency: Deadweight Loss: The loss in total surplus that occurs whenever an action/policy reduces the quantity transacted below the efficient market equilibrium quantity. Inefficient allocation to customers (those with higher willingness to pay have the same chances of getting the product as those with lower WTO) Wasted Resources Inefficiently Low Quality Black Markets Price Floors: The minimum price buyers are required to pay for a good/service. It must be above equilibrium price to be binding. They lead to surpluses as supply rises but demand falls. E.g. Minimum Wage leads to excess labour (unemployment). How Floors cause Inefficiency: Deadweight Loss Inefficient Allocation of sales among sellers (those with a lower willingness to sell have the same chances to sell as those who have a higher willingness to sell) Wasted Resources Inefficiently high quality Temptation to break the law by selling below the legal price Both floors and ceilings reduce the quantity being bought and sold. References: Notes based on EC4101 Lecture Slides and the relevant readings from Economics (12th Ed.) David Begg. Image 1: corporatefinanceinstitute.com