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

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into price ceilings [br]and also price floors.

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These are important [br]for two reasons.

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First, governments around [br]the world, both today

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and historically, often do impose [br]price ceilings and floors

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so we want to [br]understand their effects.

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Second, in the last section,[br]we explained how a price is

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a signal wrapped up [br]in an incentive.

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In this section, we'll be[br]explaining, well, what happens

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when that signal, that price, [br]is not allowed to do its work?

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When the price is not [br]allowed to rise or fall,

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what happens when [br]that signal 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 [br]allowed by law.

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

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

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It's called a ceiling[br]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, [br]reductions in product quality,

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wasteful lines[br]and other search costs,

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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 [br]each of these --

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let's begin with shortages.

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We can easily show [br]that price ceilings create shortages

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using our standard [br]demand and supply framework.

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We'll use the price of gasoline[br]as an example

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because governments often[br]have imposed

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a maximum price on gasoline.

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

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would be found [br]where the quantity demanded

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is equal to the quantity supplied.

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But suppose that the government[br]imposes a maximum price

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which is below [br]the market equilibrium.

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So, this is a controlled price, [br]a maximum price

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above which it is illegal [br]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 [br]what happens.

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So at the controlled price, [br]we can read

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

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At the controlled price,[br]the quantity supplied is

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given by the supply curve [br]and is read here.

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Notice that at the controlled price, [br]the quantity demanded

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

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

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the quantity supplied, [br]buyers want more of this good

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

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Ordinarily, the buyers would [br]compete to push the price up,

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and the price would increase [br]to the market price,

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and we would get [br]the usual equilibrium.

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

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So as a result, the quantity demanded[br]exceeds the quantity supplied,

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

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The shortage is defined[br]simply as the amount

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by which the quantity demanded [br]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, [br]that is when the quantity

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demanded exceeds [br]the quantity supplied,

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sellers have more [br]customers than goods.

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Usually, sellers have [br]to compete to get customers,

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but when goods are in shortage,

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sellers have more customers [br]than they need.

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

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cut their costs, [br]and still sell everything

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they want to sell [br]at the controlled price.

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As a result, price controls [br]reduce quality.

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We saw this in the 1970s.

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Books were printed [br]on lower quality paper.

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Two-by-four lumber shrank

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to one and five-eighths [br]by three and five-eighths.

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Automobiles were given [br]fewer coats of paint.

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Throughout the U.S. economy,[br]quality began to fall.

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Here's another example --[br]the great matzo ball debate.

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

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

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So serious was this [br]that the Chairman of the Wage

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

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

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how many matzo balls [br]were in the soup.

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He said there were still four.

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

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Price controls reduce quality.

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When the quantity demanded [br]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 [br]to give good service.

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So another way to reduce quality is [br]to reduce service.

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

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The owners would simply [br]close up shop

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whenever they wanted [br]to take a break.

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More generally there's [br]a reason why

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the baristas at Starbucks [br]are pleasant to us.

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It's because they want [br]more customers.

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

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when there's a shortage, [br]when a seller has more customers

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

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Indeed, it may pay to be unpleasant [br]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 [br]why the workers at the DMV are

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on average probably [br]a little bit less pleasant to us

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than at stores [br]which require our service,

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than at stores which want us [br]to come into the store.

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This is a reason why [br]in communist countries

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like the ex-Soviet Union, [br]the workers at the stores were

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much more unpleasant [br]than workers at McDonald's are.

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

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they want to create [br]a pleasant experience.

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

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But when there's shortages, [br]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 [br]remember five important effects.

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Shortages and reductions [br]in product quality --

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that's what we covered today.

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

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

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

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

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