WEBVTT 00:00:09.250 --> 00:00:13.370 - [Alex] In the next several videos, we'll dive deeper into price ceilings and also price 00:00:13.550 --> 00:00:18.890 floors. These are important for two reasons. First, governments around the 00:00:19.070 --> 00:00:23.216 world, both today and historically, often do impose price ceilings and floors. 00:00:23.216 --> 00:00:25.469 So we want to understand their effects. 00:00:25.469 --> 00:00:32.110 Second, in the last section we explained how a price is a signal wrapped up in an 00:00:32.290 --> 00:00:37.300 incentive. In this section, we'll be explaining what happens when that signal, 00:00:37.480 --> 00:00:42.100 that price, is not allowed to do its work. When the price is not allowed to rise or 00:00:42.280 --> 00:00:44.981 fall, what happens when that signal is not sent? 00:00:44.981 --> 00:00:47.992 What happens when that incentive is taken away? 00:00:52.830 --> 00:00:58.280 A price ceiling is a maximum price allowed by law. So for example, if the price 00:00:58.460 --> 00:01:04.550 ceiling on gasoline is $2.50, it is illegal to buy or sell gasoline at 00:01:04.730 --> 00:01:10.500 above that price. It's called a ceiling because you cannot go above the ceiling. 00:01:10.680 --> 00:01:16.790 So a ceiling is a maximum price. It has five important effects. It's going to 00:01:16.970 --> 00:01:23.520 create shortages, reductions in product quality, wasteful lines and other search 00:01:23.700 --> 00:01:27.448 costs, a loss in gains from trade or a deadweight loss, 00:01:27.448 --> 00:01:31.133 and a misallocation of resources. 00:01:31.330 --> 00:01:35.760 We're going to go through each of these - let's begin with shortages. We can easily 00:01:35.940 --> 00:01:39.660 show that price ceilings create shortages using our standard demand and supply 00:01:39.840 --> 00:01:44.350 framework. We'll use the price of gasoline as an example because governments often 00:01:44.530 --> 00:01:48.010 have imposed a maximum price on gasoline. 00:01:48.190 --> 00:01:52.750 Now, ordinarily, we would know that the market equilibrium would be found where the 00:01:52.930 --> 00:01:57.310 quantity demanded is equal to the quantity supplied. But suppose that the government 00:01:57.490 --> 00:02:02.530 imposes a maximum price which is below the market equilibrium. So, this is a 00:02:02.710 --> 00:02:06.424 controlled price, a maximum price above which it is 00:02:06.424 --> 00:02:08.722 illegal to buy or sell this good. 00:02:08.722 --> 00:02:15.140 What we want to do now is simply read off the diagram what happens. So at the 00:02:15.320 --> 00:02:19.640 controlled price, we can read that the quantity demanded, given by the demand 00:02:19.820 --> 00:02:25.100 curve, is here. At the controlled price, the quantity supplied is given by the 00:02:25.280 --> 00:02:30.000 supply curve and is read here. Notice that at the controlled price, the quantity 00:02:30.180 --> 00:02:34.047 demanded exceeds the quantity supplied and that's the shortage. 00:02:34.940 --> 00:02:40.070 Now, ordinarily, if the quantity demanded exceeded the quantity supplied, buyers 00:02:40.250 --> 00:02:46.130 want more of this good than they're able to get at the current price. Ordinarily, 00:02:46.310 --> 00:02:51.090 the buyers would compete to push the price up and the price would increase to the 00:02:51.270 --> 00:02:53.879 market price and we would get the usual equilibrium. 00:02:54.480 --> 00:02:59.220 In this case, however, it's illegal to push the price up. So as a result, the 00:02:59.400 --> 00:03:04.210 quantity demanded exceeds the quantity supplied and we get this shortage which 00:03:04.390 --> 00:03:09.900 doesn't go away. The shortage is defined simply as the amount by which the quantity 00:03:10.080 --> 00:03:14.407 demanded exceeds the quantity supplied at the controlled price. 00:03:15.410 --> 00:03:19.620 Let's give some examples. When goods are in shortage, that is when the quantity 00:03:19.800 --> 00:03:25.490 demanded exceeds the quantity supplied, sellers have more customers than goods. 00:03:25.670 --> 00:03:30.050 Usually, sellers have to compete to get customers. But when goods are in shortage, 00:03:30.230 --> 00:03:35.470 sellers have more customers than they need. As a result, when we have 00:03:35.650 --> 00:03:41.640 shortages, the sellers can cut quality, cut their costs, and still sell everything 00:03:41.820 --> 00:03:44.478 they want to sell at the controlled price. 00:03:44.890 --> 00:03:50.150 As a result, price controls reduce quality. We saw this in the 1970s. Books 00:03:50.330 --> 00:03:55.140 were printed on lower quality paper. Two-by-four lumber shrank to one and 00:03:55.320 --> 00:03:59.330 five-eighths by three and five-eighths. Automobiles were given fewer coats of 00:03:59.510 --> 00:04:05.230 paint. Throughout the U.S. economy quality began to fall. Here's another example - the 00:04:05.410 --> 00:04:09.603 great Matzo Ball Debate. In 1972 union leader, George Meany 00:04:09.603 --> 00:04:14.210 complained that his favorite soup, Mrs. Adler's, had shrunk from four to three 00:04:14.390 --> 00:04:18.470 matzo balls. So serious was this that the Chairman of the Wage and Price Commission 00:04:18.649 --> 00:04:23.370 had his staff buy up a bunch of cans of Mrs. Adler's soup, and count in each one 00:04:23.550 --> 00:04:27.620 of them how many matzo balls were in the soup. He said they were still four. 00:04:27.800 --> 00:04:31.309 Whoever was right, however, the lesson is quite correct. 00:04:31.309 --> 00:04:34.033 Price controls reduce quality. 00:04:34.033 --> 00:04:38.760 When the quantity demanded exceeds the quantity supplied, when there's a surplus 00:04:38.940 --> 00:04:43.470 of buyers, sellers have less of an incentive to give good service. 00:04:43.631 --> 00:04:48.570 Another way to reduce quality is to reduce service. And indeed, full-service gasoline 00:04:48.750 --> 00:04:53.120 stations disappeared in 1973. The owners would simply close up shop whenever they 00:04:53.300 --> 00:04:54.879 wanted to take a break. 00:04:54.879 --> 00:04:59.621 More generally there's a reason why the baristas at Starbucks are pleasant to us. 00:04:59.621 --> 00:05:05.330 It's because they want more customers. Customers are profitable, but when you 00:05:05.510 --> 00:05:09.750 can't raise the price, when there's a shortage, when a seller has more customers 00:05:09.930 --> 00:05:14.050 than they need, it doesn't pay to be pleasant to customers. Indeed, it may pay 00:05:14.230 --> 00:05:18.530 to be unpleasant to drive some of them off, so you don't have to serve them. 00:05:18.710 --> 00:05:24.230 This is another reason why the workers at the DMV are on average probably a little 00:05:24.410 --> 00:05:28.850 bit less pleasant to us than at stores which require our service, than the store 00:05:29.030 --> 00:05:34.680 which want us to come into the store. This is a reason why in communist countries 00:05:34.860 --> 00:05:39.920 like the ex-Soviet Union, the workers at the stores were much more unpleasant than 00:05:40.100 --> 00:05:44.440 workers in McDonald's are. Because McDonald's has an incentive to get more 00:05:44.620 --> 00:05:48.930 customers. They want to create a pleasant experience. They want to make it easy to 00:05:49.110 --> 00:05:54.790 buy goods from the store. But when there's shortages, when there are more customers 00:05:54.970 --> 00:05:58.470 than you need, it no longer pays to be pleasant. 00:05:58.650 --> 00:06:01.516 Okay, price ceilings, let's remember five important effects. 00:06:01.516 --> 00:06:04.330 Shortages and reductions in product quality - 00:06:04.330 --> 00:06:08.390 that's what we covered today. Next we will be covering wasteful lines and other search 00:06:08.570 --> 00:06:12.545 costs, a loss in gains from trade, and a misallocation of resources. 00:06:13.450 --> 00:06:18.510 - [Announcer] If you want to test yourself, click Practice Questions. Or, if you're ready to 00:06:18.690 --> 00:06:20.983 move on, just click Next Video.