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♪ [music] ♪

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- [Alex] In the next several videos, 
we'll dive deeper

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into price ceilings 
and also price floors.

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These are important 
for two reasons.

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First, governments around 
the world, both today

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and historically, often do 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 how a price is

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a signal wrapped up 
in an incentive.

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In this section, we'll be
explaining what happens

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when that signal, that price, 
is not allowed to do its work.

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When the price is not 
allowed to rise or fall,

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what happens when 
that signal is not sent?

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What happens when that
incentive is taken away?

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A price ceiling is a maximum price 
allowed by law.

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So for example, if the price
ceiling on gasoline is $2.50, 


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it is illegal to buy or sell 
gasoline at above that price.

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It's called a ceiling
because you cannot go

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above the ceiling.

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So a ceiling is a maximum price.

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It has five important effects.

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It's going to create shortages, 
reductions in product quality,

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wasteful lines
and other search costs,

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a loss in gains from trade,
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 --

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let's begin with shortages.

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We can easily show 
that price ceilings create shortages

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using our standard 
demand and supply framework.

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We'll use the price of gasoline
as an example

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because governments often
have imposed

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a maximum price on gasoline.

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Now, ordinarily, we would know 
that the market equilibrium

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would be found 
where the quantity demanded

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is equal to the quantity supplied.

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But suppose that the government
imposes a maximum price

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which is below 
the market equilibrium.

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So, this is a controlled price, 
a maximum price

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above which it is illegal 
to buy or sell this good.

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What we want to do now is

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simply read off the diagram 
what happens.

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So at the controlled price, 
we can read

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that the quantity demanded
given by the demand curve, is here.

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At the controlled price,
the quantity supplied is

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given by the supply curve 
and is read here.

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Notice that at the controlled price, 
the quantity demanded

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exceeds the quantity supplied 
and that's the shortage.

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Now, ordinarily, if the quantity 
demanded exceeded

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the quantity supplied, 
buyers want more of this good

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than they're able
to get at the current price.

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Ordinarily, the buyers would 
compete to push the price up,

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and the price would increase 
to the market price,

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and we would get 
the usual equilibrium.

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In this case, however, it's illegal 
to push the price up.

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As a result, the quantity demanded
exceeds the quantity supplied,

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and we get this shortage 
which doesn't go away.

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The shortage is defined
simply as the amount

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by which the quantity demanded 
exceeds the quantity supplied

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at the controlled price.

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Let's give some examples.

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When goods are in shortage, 
that is when the quantity

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demanded exceeds 
the quantity supplied,

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sellers have more 
customers than goods.

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Usually, sellers have 
to compete to get customers,

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but when goods are in shortage,

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sellers have more customers 
than they need.

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As a result, when we have shortages,
the sellers can cut quality,

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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 quality.

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We saw this in the 1970s.

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Books were printed 
on lower quality paper.

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Two-by-four lumber shrank

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to one and five-eighths 
by three and five-eighths.

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Automobiles were given 
fewer coats of paint.

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Throughout the U.S. economy,
quality began to fall.

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Here's another example --
the great Matzo Ball Debate.

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In 1972 union leader George Meany
complained that his favorite soup,


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Mrs. Adler's, had shrunk 
from four to three matzo balls.

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So serious was this 
that the Chairman of the Wage

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and Price Commission had his staff 
buy up a bunch of cans

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of Mrs. Adler's soup
and count in each one of them

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how many matzo balls 
were in the soup.

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He said there were still four.

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Whoever was right, however, 
the lesson is quite correct.

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Price controls reduce quality.

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When the quantity demanded 
exceeds the quantity supplied,

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when there's a surplus of buyers,

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sellers have less of an incentive 
to give good service.

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Another way to reduce quality is 
to reduce service.

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And indeed, full-service gasoline 
stations disappeared in 1973.

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The owners would simply 
close up shop

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whenever they wanted 
to take a break.

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More generally there's 
a reason why

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the baristas at Starbucks 
are pleasant to us.

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It's because they want 
more customers.

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Customers are profitable, 
but when you can't raise the price,

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when there's a shortage, 
when a seller has more customers

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than they need, it doesn't pay 
to be pleasant to customers.

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Indeed, it may pay to be unpleasant 
to drive some of them off,

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so you don't have to serve them.

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This is another reason 
why the workers at the DMV are

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on average probably 
a little bit less pleasant to us

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than at stores 
which require our service

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than the stores which want us 
to come into the store.

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This is a reason why 
in communist countries

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like the ex-Soviet Union, 
the workers at the stores were

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much more unpleasant 
than workers in McDonald's are.

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Because McDonald's has an incentive 
to get more customers,

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they want to create 
a pleasant experience.

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They want to make it easy 
to buy goods from the store.

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But when there's shortages, 
when there are more customers

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

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

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Shortages and reductions 
in product quality --

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that's what we covered today.

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Next we will be covering wasteful
lines and other search costs,

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a loss in gains from trade, 
and a misallocation of resources.

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- [Narrator] If you want to test 
yourself, click "Practice Questions."

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Or, if you're ready to move on,
just click "Next Video."

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♪ [music] ♪