Market driven -- i.e., supply and demand driven
-- price and quantity presume we have a free
market; that is, a market that's free of any
outside intervention, and is allowed to “do
its own thing.”
Who has the power and motivation to interfere
with the market mechanism?
The government may interfere with market operations,
if it feels it is protecting society, or some
part of society, from harm.
The government will establish a price floor
-- a legal minimum price for the market – if
it feels that the market price is too low.
Thus, the price floor will be set above the
equilibrium.
Who is the price floor meant to protect?
The price floor is meant to protect the seller.
From what?
Well, a price that's too low for sellers would
be too low to cover costs, and keep the seller
business.
What kinds of businesses will be important
enough to warrant this kind of government
help?
Typically, agriculture or food industries;
the government feels the need to support the
farmers in order to keep our domestic food
supply intact.
OK, so the government imposes a price floor,
Pf, on this market.
Let's say that this is the market for milk
in upstate New York, as was the case some
years back.
What happens at Pf?
Dairy farmers are quite happy with this price,
and are willing to provide QS units of milk.
The consumers, however, aren't too keen on
this price, and are only willing to buy Qd
units of milk.
The result of the price floor?
A surplus of milk in the market.
No problem, right?
Surpluses are easy enough to fix; the price
drops and… oops.
The price cannot adjust downward to get rid
of the surplus.
Now what?
Well, maybe the government could buy up all
the surplus, but then what do they do with
it?
I don’t know -- maybe give it to schools?
The troops?
The homeless?
Foreign countries?
Any of these uses would require a pretty extensive
(and expensive) distribution network and bureaucracy
paid for by -- you guessed it -- the taxpayers!
So, now we're paying high prices for milk,
AND paying to buy and distribute the excess?
Well, what if the government decides it’s
not such a great idea, and refuses to buy
the surplus?
“Hey, you farmers, we’re already keeping
the price of the milk propped up – deal
with your own surplus!”
Now what happens?
No one wants the milk at the high prices,
and it isn’t legal to sell it below Pf.
In upstate New York, a lot of farms have creeks
running through the property, and farmers
dumped their surplus milk out back -- into
the creek, and on into the Susquehanna and
Chenango rivers.
Question: rather than impose an artificial
price on the market, resulting in all manner
of other problems, is there any way to, well,
manage the market to get the equilibrium price
up to Pf , where we want it to be?
Well, sure -- we could alter the underlying
market conditions, the demand and supply.
How do you push price upward by using demand?
You increase the demand for milk, maybe by
using celebrities in a nationwide “Got milk?”
campaign, or by citing research that says
milk helps you lose weight.
On the supply side, if the milk supply could
be reduced, price would rise; this is often
why you hear about the government paying farmers
NOT to produce their product.
What about the other side?
Price ceilings are established when the government
feels that the market equilibrium price is
too high.
Too high for whom?
For buyers.
Price ceilings are meant to protect buyers
from high prices.
Not for all products, mind you; price ceilings
are more likely to be applied to products
that everyone needs, that are perceived as
being necessary, and necessarily affordable,
to all income groups.
Housing, like rent controls, and energy are
typical candidates for price ceilings.
Consider gasoline.
Just after 9/11, both state and federal proposals
were made to cap the price of gasoline at
$2.50 a gallon, to prevent price gouging at
the pump.
Sounds like a pretty good deal, compared to
three or four dollar gas, doesn't it?
But consider the implications -- the proposed
price ceiling, PC, was to be at $2.50 a gallon,
but the actual market equilibrium price is,
say, $4 a gallon.
At price PC, the price ceiling, consumers
are very happy.
They want to buy Qd gallons of gas.
Gas station owners, however, are only willing
to provide Qs gallons of gas at this price.
This means that not everyone is going to get
the gasoline that they want, because there
is a shortage.
Well that’s OK, right?
As a result of the shortage, prices will rise
and… wait!
Prices can’t rise!
So what happens?
Rationing?
Black markets for gasoline?
Long lines at the pump?
Think about this: Would you rather KNOW that
you can get gas as long as you're willing
to pay $4 a gallon, or HOPE that you can get
gas at the price ceiling of $2.50?
Is there a way to make $2.50 the equilibrium
price, instead of imposing it on the market
as an artificial price, and creating a shortage
that leads to other problems?
Yes.
If we could, say, decrease the demand for
gas -- say, more public transit, better fuel
mileage on cars, more conservation – and/or
increase the supply of gas -- maybe open the
national strategic reserves or drill of the
Alaskan Wildlife Refuge, etcetera -- then
you would push the price closer to where we
wanted to be.
NEXT TIME:
For microeconomics – elasticity.
For macroeconomics – inflation.
TRANSCRIPT0 EPISODE 15: PRICE FLOORS AND PRICE
CEILINGS
