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- [Alex] In the next several videos,
we'll dive deeper
into price ceilings
and also price floors.
These are important
for two reasons.
First, governments around
the world, both today
and historically, often do impose
price ceilings and floors
so we want to
understand their effects.
Second, in the last section,
we explained how a price is
a signal wrapped up
in an incentive.
In this section, we'll be
explaining what happens
when that signal, that price,
is not allowed to do its work.
When the price is not allowed to rise or
fall, what happens when that signal
is not sent?
What happens when that
incentive is taken away?
A price ceiling is a maximum price allowed
by law. So for example, if the price
ceiling on gasoline is $2.50, it is
illegal to buy or sell gasoline at
above that price. It's called a ceiling
because you cannot go above the ceiling.
So a ceiling is a maximum price. It has
five important effects. It's going to
create shortages, reductions in product
quality, wasteful lines and other search
costs, a loss in gains from trade
or a deadweight loss,
and a misallocation of resources.
We're going to go through each of these -
let's begin with shortages. We can easily
show that price ceilings create shortages
using our standard demand and supply
framework. We'll use the price of gasoline
as an example because governments often
have imposed a maximum price on gasoline.
Now, ordinarily, we would know that the
market equilibrium would be found where the
quantity demanded is equal to the quantity
supplied. But suppose that the government
imposes a maximum price which is below the
market equilibrium. So, this is a
controlled price, a maximum
price above which it is
illegal to buy or sell this good.
What we want to do now is simply read off
the diagram what happens. So at the
controlled price, we can read that the
quantity demanded, given by the demand
curve, is here. At the controlled price,
the quantity supplied is given by the
supply curve and is read here. Notice that
at the controlled price, the quantity
demanded exceeds the quantity
supplied and that's the shortage.
Now, ordinarily, if the quantity demanded
exceeded the quantity supplied, buyers
want more of this good than they're able
to get at the current price. Ordinarily,
the buyers would compete to push the price
up and the price would increase to the
market price and we would get the
usual equilibrium.
In this case, however, it's illegal to
push the price up. So as a result, the
quantity demanded exceeds the quantity
supplied and we get this shortage which
doesn't go away. The shortage is defined
simply as the amount by which the quantity
demanded exceeds the quantity
supplied at the controlled price.
Let's give some examples. When goods are
in shortage, that is when the quantity
demanded exceeds the quantity supplied,
sellers have more customers than goods.
Usually, sellers have to compete to get
customers. But when goods are in shortage,
sellers have more customers than they
need. As a result, when we have
shortages, the sellers can cut quality,
cut their costs, and still sell everything
they want to sell at the controlled price.
As a result, price controls reduce
quality. We saw this in the 1970s. Books
were printed on lower quality paper.
Two-by-four lumber shrank to one and
five-eighths by three and five-eighths.
Automobiles were given fewer coats of
paint. Throughout the U.S. economy quality
began to fall. Here's another example - the
great Matzo Ball Debate.
In 1972 union leader, George Meany
complained that his favorite soup, Mrs.
Adler's, had shrunk from four to three
matzo balls. So serious was this that the
Chairman of the Wage and Price Commission
had his staff buy up a bunch of cans of
Mrs. Adler's soup, and count in each one
of them how many matzo balls were in the
soup. He said they were still four.
Whoever was right, however, the lesson is
quite correct.
Price controls reduce quality.
When the quantity demanded exceeds the
quantity supplied, when there's a surplus
of buyers, sellers have less of an
incentive to give good service.
Another way to reduce quality is to reduce
service. And indeed, full-service gasoline
stations disappeared in 1973. The owners
would simply close up shop whenever they
wanted to take a break.
More generally there's a reason why the
baristas at Starbucks are pleasant to us.
It's because they want more customers.
Customers are profitable, but when you
can't raise the price, when there's a
shortage, when a seller has more customers
than they need, it doesn't pay to be
pleasant to customers. Indeed, it may pay
to be unpleasant to drive some of them
off, so you don't have to serve them.
This is another reason why the workers at
the DMV are on average probably a little
bit less pleasant to us than at stores
which require our service, than the store
which want us to come into the store. This
is a reason why in communist countries
like the ex-Soviet Union, the workers at
the stores were much more unpleasant than
workers in McDonald's are. Because
McDonald's has an incentive to get more
customers. They want to create a pleasant
experience. They want to make it easy to
buy goods from the store. But when there's
shortages, when there are more customers
than you need, it no longer
pays to be pleasant.
Okay, price ceilings, let's remember five
important effects.
Shortages and reductions in
product quality -
that's what we covered today. Next we will
be covering wasteful lines and other search
costs, a loss in gains from trade, and a
misallocation of resources.
- [Announcer] If you want to test yourself, click
Practice Questions. Or, if you're ready to
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