Hi folks, this is going to be chapter 4,
part 1, and before we get into government
price setting it's important that you
understand consumer and producer surplus.
I'm assuming you've read this already...
it's covered exhaustively in your
textbook, but if you haven't or you need
a quick refresher let me quickly
summarize consumer and producer surplus.
When we have a market that's in
equilibrium
everyone who purchases gets to purchase
at the equilibrium price.  There were lots
of folks who would have been willing to
pay more than the equilibrium price for
this product though.  That's evidenced by
the fact that the demand curve is
actually above the equilibrium or I
should say there's areas of the demand
curve that are above the equilibrium.  The
area that's underneath the demand curve
but above the equilibrium price
represents all of the good deals that
consumers were able to capture by buying
at the market price.  This is referred to
as consumer surplus.  Producer surplus is
the exact opposite, or perhaps a
corollary.  Producers get to sell all of
their output at the equilibrium price,
but there were lots of them, as evidenced
by this portion of the supply curve, that
would have been willing to sell it for
lower amounts.  Because they didn't have
to they captured what is known as a
producer surplus.  That's this area here.
We're going to use those in our
discussions of ceilings and floors and we'll
be able to tell what the impacts are on
efficiency once a government starts
setting price.
Okay, so let's look at some instances
where the government actually mandates a
minimum price in a market or a maximum
price.  When the government mandates a
minimum price there are in essence
putting into place a price floor.  Now for
that floor to actually make any
difference whatsoever it's got to be
above the equilibrium, because if it were
a minimum price below the equilibrium no
one would care. So before we start to
look at the implications of a price
floor let's go ahead and mark out the
original equilibrium and our original
consumer and producer surplus triangles.
We'lll mark out the producer here in blue and
let's use red for the consumer.  Those two
triangles represent our original
starting points before any floor is put
into place.  Once we put a floor into
place we now have a mandated minimum
price and this minimum price is of
course going to raise the cost of air
travel for consumers.
As air travel got more expensive during
the late 30s to the mid-70s consumers
stopped taking as many intrastate trips. 
These were the ones that were regulated
quantity fell because of course it
doesn't matter if you've set a new
higher minimum price if you can't find
buyers.  So what does this mean for our
market  and efficiency. 
Well for starters consumers not buying
means that sellers aren't selling those
flights either so this portion of the
producer surplus is gone and this
portion of the consumer surplus is gone.
Collectively this triangle here in black
is referred to as deadweight loss, and
the easiest way to understand this is... it
is loss transactions... you can't get good
deals on flights that you're not
purchasing or selling.  Aside from this
inefficiency represented by deadweight
loss,
you also can recognize that there is a
chunk of the consumer surplus triangle
that is no longer theirs.  This portion
here marked out in blue is actually
going to be transferred over to the
producer, because they do get to charge
this new minimum price at the price
floor. And all of the area under the
price they get and above their supply
curve is producer surplus.
So that rectangle gets added on to
what's left of their original blue
triangle.   The consumer gets the worst of
this deal.  All that's left for them of
their original red triangle is this tiny
triangle here on top.  So what to make of
this price floor.  One you've got to
recognize that the price floor is causing
inefficiently low output.  When we drive
quantity down to q1 we know that this
last unit here had an MB, as represented
by the value that a consumer
was willing to pay for this last flight,
that is greater than the marginal cost,
which is represented by the price that a
producer would have needed to provide
that last flight.  If MB is greater than
MC, then we're violating our golden rule
and we've introduced in allocative
inefficiency.  On top of that we also have
another result we'll refer to as
number two. We get inefficient allocation
among sellers.   This new artificially high
price allows some airlines to hang on
even though they wouldn't have been
competitive if you'd force them to
compete with other airlines that may
have wanted to enter in.  You're also
going to get wasted resources, number
three.  You're going to get people who
hang around and they shouldn't be here
and aside from that you're probably
going to get a fair amount of people
competing on the basis of quality..and
this high quality is actually a problem. 
I know it seems strange, but when you
don't allow firms to actively compete,
then what you're going to end up with is
they compete not on price, but they
compete on non-price factors.  We saw all
of these airlines starting to get about
blankets and peanuts and snacks and all
of these in-flight amenities.  These
in-flight amenities are nice, but I think
that if you ask most people if they'd
rather peanuts and a blanket or they'd
rather the flight be a hundred dollars
cheaper....most of them were probably going
to say that they would have taken the
cheaper flight.  Hence, we get an
inefficiently
high quality.  Lastly, whenever there's a
minimum price or a maximum price in
place there's the potential for illegal
activity.  Mostly because you haven't
changed the fact that there were
suppliers who were willing to produce at
these lower prices and there were
obviously folks would be happy to pay
lower prices.
So just because you've made it illegal
doesn't mean you've changed the fact
that people would have willingly engaged
in those transactions.  Okay let's take a
crack at price maximums, which is really
what a price ceiling is.  Start out once
again and we'll mark out our original
equilibrium price and our original
equilibrium quantity...and we can
highlight our original consumer surplus,
have an intersection up here at the top,
and our original producer surplus. So
what happens when we actually impose a
price maximum??  In order for it to matter It's got
to be below the equilibrium, otherwise
everyone would just ignore it and
transact at the equilibrium price. So
essentially what you're doing with a
price ceiling is you are lowering the
price and for obvious reasons consumers
are going to get excited about that. 
They're going to want to go ahead... and
they would have a much higher quantity
demanded at this lower price for
apartments.  Okay the downside for them is
that there aren't as many producers who
are actually willing and able to supply
at that price.  So some of those producers
might immediately start thinking about
converting into condos or selling their
property...and of course just like with a
floor it's the short side of the market
that matters.  You have to find willing
buyers and sellers, and so without as
many willing sellers it doesn't really
matter that there's lots of folks who
would like an apartment at this lower
rate.  So you're going to end up with
deadweight loss in a ceiling just like
you had deadweight loss in a floor.  All
of this area represents lost
transactions or deadweight loss... can't
get good deals on apartments that aren't
being bought or sold, these are  just lost,  so
this is of course why we have our first
result which is inefficiently low output.
Now aside from seeing the deadweight
loss we can also talk about
transfers of consumer surplus...uh, actually transfers of producer surplus to the
consumer now,  because of course they're
the ones who are going to benefit from
this lower price. This rectangle which
used to be part of the producer is now
going to get transferred to the consumer
and they'll add that onto their already
existing consumer surplus . The producer left
with whatever they previously had minus the
transfer.   So effectively a ceiling is
sort of like a tax on producers that
distributes that economic surplus to
consumers,  and of course market folks are
upset about this because it's going to
lead to an inefficient allocation
amongst consumers.  You're going to get
consumers who now get some of the
existing housing stock that weren't the
people who were willing to pay the most
for it . Market folks would say that they
are the ones who are inefficient because
they were not the ones who would have
been willing to pay the most for the
resource.  In other words the resources
aren't generating as much happiness as it
might have otherwise. 
Now there's something subtle going on
here.  I want you to recognize that the
way that market folks are talking about
this is that someone's deservedness 
of a resource is only reflected by their
willingness and their ability to pay for
that resource.  Social justice folks and
people who are more interested in some
of the normative stuff are going to
freak out about that...and  in fact there's
something may be a little bit icky when
you really think about market rationing, 
especially when we're talking about
basic necessities of life.  Market
rationing means that if there isn't
enough of something whoever can spend
the most on it are the ones who report
on quote value at the most and they're
the ones who quote unquote should get it.
Okay,
back to our list here you can expect
wasted resources with a ceiling as well,
because with this new shortage that
exists in the housing market you're
going to have a lot of folks running
around and looking for housing when they
wouldn't have had to bother with that at
all.  They could have just rented a place
easily before the shortage . You're also
going to end up finding that the
existing housing stock isn't as well
maintained, because you don't need to
maintain a building well if you've got a
whole horde of people that are always
scrambling to get into a vacant
apartment.  You don't need to fix the sink..
you can neglect all sorts of normal
landlord duties.  You also are going to
expect underground markets.  If it's really
that difficult to get an apartment it's
not going to take long before people
start bribing landlords to get on the
list and perhaps even paying above
the legally mandated ceiling.  This would
of course be an underground or an
illegal transaction, but they both have
obvious incentives to engage in this, and
this is one of the problems with legally
mandating prices... you never changed people's
willingness to buy or to sell.  You just
told them they can't do it. Okay as a
brief aside we've looked at floors and
we've looked at ceilings now,  an
economist would tell you that these are
positive analyses of the efficiency
impacts from price minimums and maximums. 
They're right about that, but don't miss
out on the hidden assumption that
efficiency is the thing that should be
privileged.  Lots of folks would argue in
favor of ceilings or floors recognize
that it's going to cause some
inefficiencies, but they really don't
care because there's some other
normative value that they think is worth
suffering the inefficiency for.  I think
that's a fair way to look at a lot of
these things,  anyway it gives you
something else to chew on.  I'll talk to
you soon.
