0:00:00.000,0:00:06.570 ♪ [music] ♪ 0:00:06.570,0:00:10.550 - [Alex] In the next several videos, [br]we'll dive deeper 0:00:10.550,0:00:13.550 into price ceilings [br]and also price floors. 0:00:13.550,0:00:18.890 These are important [br]for two reasons. 0:00:19.070,0:00:20.216 First, governments around [br]the world, both today 0:00:20.216,0:00:23.216 and historically, often do impose [br]price ceilings and floors 0:00:23.216,0:00:25.469 so we want to [br]understand their effects. 0:00:25.469,0:00:32.110 Second, in the last section,[br]we explained how a price is 0:00:32.290,0:00:34.480 a signal wrapped up [br]in an incentive. 0:00:34.480,0:00:35.480 In this section, we'll be[br]explaining what happens 0:00:35.480,0:00:37.480 when that signal, that price, [br]is not allowed to do its work. 0:00:37.480,0:00:42.100 When the price is not [br]allowed to rise or fall, 0:00:42.280,0:00:44.981 what happens when [br]that signal is not sent? 0:00:44.981,0:00:47.992 What happens when that[br]incentive is taken away? 0:00:52.830,0:00:55.460 A price ceiling is a maximum price [br]allowed by law. 0:00:55.460,0:00:58.460 So for example, if the price[br]ceiling on gasoline is $2.50, [br] 0:00:58.460,0:01:04.550 it is illegal to buy or sell [br]gasoline at above that price. 0:01:04.730,0:01:07.680 It's called a ceiling[br]because you cannot go 0:01:07.680,0:01:10.680 above the ceiling. 0:01:10.680,0:01:13.970 So a ceiling is a maximum price. 0:01:13.970,0:01:16.970 It has five important effects. 0:01:16.970,0:01:23.520 It's going to create shortages, [br]reductions in product quality, 0:01:23.700,0:01:27.448 wasteful lines[br]and other search costs, 0:01:27.448,0:01:28.448 a loss in gains from trade,[br]or a deadweight loss, 0:01:28.448,0:01:31.330 and a misallocation of resources. 0:01:31.330,0:01:32.940 We're going to go through [br]each of these -- 0:01:32.940,0:01:33.940 let's begin with shortages. 0:01:33.940,0:01:35.940 We can easily show [br]that price ceilings create shortages 0:01:35.940,0:01:39.660 using our standard [br]demand and supply framework. 0:01:39.840,0:01:44.350 We'll use the price of gasoline[br]as an example because governments often 0:01:44.530,0:01:48.010 have imposed a maximum price on gasoline. 0:01:48.190,0:01:52.750 Now, ordinarily, we would know that the[br]market equilibrium would be found where the 0:01:52.930,0:01:57.310 quantity demanded is equal to the quantity[br]supplied. But suppose that the government 0:01:57.490,0:02:02.530 imposes a maximum price which is below the[br]market equilibrium. So, this is a 0:02:02.710,0:02:06.424 controlled price, a maximum[br]price above which it is 0:02:06.424,0:02:08.722 illegal to buy or sell this good. 0:02:08.722,0:02:15.140 What we want to do now is simply read off[br]the diagram what happens. So at the 0:02:15.320,0:02:19.640 controlled price, we can read that the[br]quantity demanded, given by the demand 0:02:19.820,0:02:25.100 curve, is here. At the controlled price,[br]the quantity supplied is given by the 0:02:25.280,0:02:30.000 supply curve and is read here. Notice that[br]at the controlled price, the quantity 0:02:30.180,0:02:34.047 demanded exceeds the quantity[br]supplied and that's the shortage. 0:02:34.940,0:02:40.070 Now, ordinarily, if the quantity demanded[br]exceeded the quantity supplied, buyers 0:02:40.250,0:02:46.130 want more of this good than they're able[br]to get at the current price. Ordinarily, 0:02:46.310,0:02:51.090 the buyers would compete to push the price[br]up and the price would increase to the 0:02:51.270,0:02:53.879 market price and we would get the[br]usual equilibrium. 0:02:54.480,0:02:59.220 In this case, however, it's illegal to[br]push the price up. So as a result, the 0:02:59.400,0:03:04.210 quantity demanded exceeds the quantity[br]supplied and we get this shortage which 0:03:04.390,0:03:09.900 doesn't go away. The shortage is defined[br]simply as the amount by which the quantity 0:03:10.080,0:03:14.407 demanded exceeds the quantity[br]supplied at the controlled price. 0:03:15.410,0:03:19.620 Let's give some examples. When goods are[br]in shortage, that is when the quantity 0:03:19.800,0:03:25.490 demanded exceeds the quantity supplied,[br]sellers have more customers than goods. 0:03:25.670,0:03:30.050 Usually, sellers have to compete to get[br]customers. But when goods are in shortage, 0:03:30.230,0:03:35.470 sellers have more customers than they[br]need. As a result, when we have 0:03:35.650,0:03:41.640 shortages, the sellers can cut quality,[br]cut their costs, and still sell everything 0:03:41.820,0:03:44.478 they want to sell at the controlled price. 0:03:44.890,0:03:50.150 As a result, price controls reduce[br]quality. We saw this in the 1970s. Books 0:03:50.330,0:03:55.140 were printed on lower quality paper.[br]Two-by-four lumber shrank to one and 0:03:55.320,0:03:59.330 five-eighths by three and five-eighths.[br]Automobiles were given fewer coats of 0:03:59.510,0:04:05.230 paint. Throughout the U.S. economy quality[br]began to fall. Here's another example - the 0:04:05.410,0:04:09.603 great Matzo Ball Debate.[br]In 1972 union leader, George Meany 0:04:09.603,0:04:14.210 complained that his favorite soup, Mrs.[br]Adler's, had shrunk from four to three 0:04:14.390,0:04:18.470 matzo balls. So serious was this that the[br]Chairman of the Wage and Price Commission 0:04:18.649,0:04:23.370 had his staff buy up a bunch of cans of[br]Mrs. Adler's soup, and count in each one 0:04:23.550,0:04:27.620 of them how many matzo balls were in the[br]soup. He said they were still four. 0:04:27.800,0:04:31.309 Whoever was right, however, the lesson is[br]quite correct. 0:04:31.309,0:04:34.033 Price controls reduce quality. 0:04:34.033,0:04:38.760 When the quantity demanded exceeds the[br]quantity supplied, when there's a surplus 0:04:38.940,0:04:43.470 of buyers, sellers have less of an[br]incentive to give good service. 0:04:43.631,0:04:48.570 Another way to reduce quality is to reduce[br]service. And indeed, full-service gasoline 0:04:48.750,0:04:53.120 stations disappeared in 1973. The owners[br]would simply close up shop whenever they 0:04:53.300,0:04:54.879 wanted to take a break. 0:04:54.879,0:04:59.621 More generally there's a reason why the[br]baristas at Starbucks are pleasant to us. 0:04:59.621,0:05:05.330 It's because they want more customers.[br]Customers are profitable, but when you 0:05:05.510,0:05:09.750 can't raise the price, when there's a[br]shortage, when a seller has more customers 0:05:09.930,0:05:14.050 than they need, it doesn't pay to be[br]pleasant to customers. Indeed, it may pay 0:05:14.230,0:05:18.530 to be unpleasant to drive some of them[br]off, so you don't have to serve them. 0:05:18.710,0:05:24.230 This is another reason why the workers at[br]the DMV are on average probably a little 0:05:24.410,0:05:28.850 bit less pleasant to us than at stores[br]which require our service, than the store 0:05:29.030,0:05:34.680 which want us to come into the store. This[br]is a reason why in communist countries 0:05:34.860,0:05:39.920 like the ex-Soviet Union, the workers at[br]the stores were much more unpleasant than 0:05:40.100,0:05:44.440 workers in McDonald's are. Because[br]McDonald's has an incentive to get more 0:05:44.620,0:05:48.930 customers. They want to create a pleasant[br]experience. They want to make it easy to 0:05:49.110,0:05:54.790 buy goods from the store. But when there's[br]shortages, when there are more customers 0:05:54.970,0:05:58.470 than you need, it no longer[br]pays to be pleasant. 0:05:58.650,0:06:01.516 Okay, price ceilings, let's remember five[br]important effects. 0:06:01.516,0:06:04.330 Shortages and reductions in[br]product quality - 0:06:04.330,0:06:08.390 that's what we covered today. Next we will[br]be covering wasteful lines and other search 0:06:08.570,0:06:12.545 costs, a loss in gains from trade, and a[br]misallocation of resources. 0:06:13.450,0:06:18.510 - [Announcer] If you want to test yourself, click[br]Practice Questions. Or, if you're ready to 0:06:18.690,0:06:20.983 move on, just click Next Video.