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- [Alex] In the next several videos, we'll dive[br]deeper into price ceilings and also price

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floors. These are important for two[br]reasons. First, governments around the

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world, both today and historically, often do[br]impose price ceilings and floors.

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So we want to understand their effects.

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Second, in the last section we explained[br]how a price is a signal wrapped up in an

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incentive. In this section, we'll be[br]explaining what happens when that signal,

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that price, is not allowed to do its work.[br]When the price is not allowed to rise or

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fall, what happens when that signal[br]is not sent?

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What happens when that[br]incentive is taken away?

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A price ceiling is a maximum price allowed[br]by law. So for example, if the price

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ceiling on gasoline is $2.50, it is[br]illegal to buy or sell gasoline at

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above that price. It's called a ceiling[br]because you cannot go above the ceiling.

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So a ceiling is a maximum price. It has[br]five important effects. It's going to

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create shortages, reductions in product[br]quality, wasteful lines and other search

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costs, a loss in gains from trade[br]or a deadweight loss,

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and a misallocation of resources.

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We're going to go through each of these -[br]let's begin with shortages. We can easily

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show that price ceilings create shortages[br]using our standard demand and supply

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framework. We'll use the price of gasoline[br]as an example because governments often

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have imposed a maximum price on gasoline.

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Now, ordinarily, we would know that the[br]market equilibrium would be found where the

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quantity demanded is equal to the quantity[br]supplied. But suppose that the government

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imposes a maximum price which is below the[br]market equilibrium. So, this is a

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controlled price, a maximum[br]price above which it is

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illegal to buy or sell this good.

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What we want to do now is simply read off[br]the diagram what happens. So at the

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controlled price, we can read that the[br]quantity demanded, given by the demand

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curve, is here. At the controlled price,[br]the quantity supplied is given by the

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supply curve and is read here. Notice that[br]at the controlled price, the quantity

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demanded exceeds the quantity[br]supplied and that's the shortage.

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Now, ordinarily, if the quantity demanded[br]exceeded the quantity supplied, buyers

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want more of this good than they're able[br]to get at the current price. Ordinarily,

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the buyers would compete to push the price[br]up and the price would increase to the

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market price and we would get the[br]usual equilibrium.

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In this case, however, it's illegal to[br]push the price up. So as a result, the

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quantity demanded exceeds the quantity[br]supplied and we get this shortage which

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doesn't go away. The shortage is defined[br]simply as the amount by which the quantity

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demanded exceeds the quantity[br]supplied at the controlled price.

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Let's give some examples. When goods are[br]in shortage, that is when the quantity

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demanded exceeds the quantity supplied,[br]sellers have more customers than goods.

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Usually, sellers have to compete to get[br]customers. But when goods are in shortage,

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sellers have more customers than they[br]need. As a result, when we have

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shortages, the sellers can cut quality,[br]cut their costs, and still sell everything

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they want to sell at the controlled price.

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As a result, price controls reduce[br]quality. We saw this in the 1970s. Books

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were printed on lower quality paper.[br]Two-by-four lumber shrank to one and

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five-eighths by three and five-eighths.[br]Automobiles were given fewer coats of

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paint. Throughout the U.S. economy quality[br]began to fall. Here's another example - the

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great Matzo Ball Debate.[br]In 1972 union leader, George Meany

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complained that his favorite soup, Mrs.[br]Adler's, had shrunk from four to three

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matzo balls. So serious was this that the[br]Chairman of the Wage and Price Commission

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had his staff buy up a bunch of cans of[br]Mrs. Adler's soup, and count in each one

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of them how many matzo balls were in the[br]soup. He said they were still four.

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Whoever was right, however, the lesson is[br]quite correct.

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Price controls reduce quality.

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When the quantity demanded exceeds the[br]quantity supplied, when there's a surplus

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of buyers, sellers have less of an[br]incentive to give good service.

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Another way to reduce quality is to reduce[br]service. And indeed, full-service gasoline

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stations disappeared in 1973. The owners[br]would simply close up shop whenever they

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wanted to take a break.

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More generally there's a reason why the[br]baristas at Starbucks are pleasant to us.

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It's because they want more customers.[br]Customers are profitable, but when you

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can't raise the price, when there's a[br]shortage, when a seller has more customers

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than they need, it doesn't pay to be[br]pleasant to customers. Indeed, it may pay

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to be unpleasant to drive some of them[br]off, so you don't have to serve them.

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This is another reason why the workers at[br]the DMV are on average probably a little

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bit less pleasant to us than at stores[br]which require our service, than the store

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which want us to come into the store. This[br]is a reason why in communist countries

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like the ex-Soviet Union, the workers at[br]the stores were much more unpleasant than

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workers in McDonald's are. Because[br]McDonald's has an incentive to get more

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customers. They want to create a pleasant[br]experience. They want to make it easy to

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buy goods from the store. But when there's[br]shortages, when there are more customers

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than you need, it no longer[br]pays to be pleasant.

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Okay, price ceilings, let's remember five[br]important effects.

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Shortages and reductions in[br]product quality -

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that's what we covered today. Next we will[br]be covering wasteful lines and other search

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costs, a loss in gains from trade, and a[br]misallocation of resources.

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- [Announcer] If you want to test yourself, click[br]Practice Questions. Or, if you're ready to

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