Price Ceilings: Misallocation of Resources
-
Not Synced♪ [music] ♪
-
Not Synced- [Alex] Welcome back.
-
Not SyncedAnother cost of price ceilings
is that they misallocate resources. -
Not SyncedThis is actually a point
not covered in most textbooks, -
Not Syncedbut it's very important.
-
Not SyncedAnd it's going to be important
not just to understand -
Not Syncedprice controls, but also to give us
real insight -
Not Syncedand deeper understanding
into how the price system works. -
Not SyncedLet's get started.
-
Not SyncedLet's begin with an intuitive,
but a real and important example. -
Not SyncedSuppose that over here
on the west coast -
Not Syncedof the United States,
we're having a very mild winter. -
Not SyncedTemperatures are high.
The sun is shining. No problems. -
Not SyncedLet's suppose however,
that on the east coast the winter -
Not Syncedis really bad.
-
Not SyncedIt's cold. There's a lot
of snow and so forth. -
Not SyncedAs a result of the weather,
the people on the east coast -
Not Syncedare going to be demanding
a lot of home heating oil. -
Not SyncedSo the demand
for heating oil goes up, -
Not Syncedand because of that increase
in demand we get a higher price -
Not Syncedof heating oil.
-
Not SyncedNow, what are entrepreneurs
going to do? -
Not SyncedSeeing this signal
of a higher price, -
Not Syncedthey're going to be incentivized
to take oil from where -
Not Syncedit has low value,
over here on the west coast, -
Not Syncedand bring it to where the oil
has high value on the east coast. -
Not SyncedSo oil will flow
from the west to the east. -
Not SyncedIt will flow from areas
where it has low value. -
Not SyncedIn response to the signal
of the higher price, -
Not Syncedit will flow to areas
where it has higher value. -
Not SyncedNow, let us suppose,
that as in the 1970s, -
Not Syncedwe now have a price control on oil.
-
Not SyncedSo it is illegal for the price
of oil to increase. -
Not SyncedWell, as before,
with the price control, -
Not Syncedwe're going to get higher demand
but no higher price. -
Not SyncedThere will not be that signal
of a higher price, -
Not Syncedand because there isn't a signal
there won't be an incentive -
Not Syncedto bring oil from where
it has low value -
Not Syncedto where it has high value.
-
Not SyncedSo the oil will no longer flow.
-
Not SyncedAs a result, people over here
on the west coast, -
Not Syncedthey're going to be using that oil
for low-value items, -
Not Syncedthings like heating
their swimming pool. -
Not SyncedAt the same time,
people on the east coast -
Not Syncedmay not have enough oil
to heat their homes. -
Not SyncedIn fact, this is exactly
hat happened in the 1970s. -
Not SyncedThere was a misallocation of oil
because of the price controls. -
Not SyncedOil was used in some low uses,
some low-value uses -
Not Syncedsuch as heating swimming pools,
at the same time -
Not Syncedwhen there wasn't enough oil
for the high-valued uses. -
Not SyncedThat's what we mean
by misallocation of resources. -
Not SyncedLet's take a look
at how we can show this -
Not Syncedin a diagram.
-
Not SyncedHere's our standard diagram
of the shortage. -
Not SyncedLet's remember from chapter three
that we could read -
Not Syncedthe demand curve
in the following way. -
Not SyncedAt the top of the demand curve
are the highest-valued uses -
Not Syncedfor the good.
-
Not SyncedThis is Air Force One,
if you recall the example -
Not Syncedfrom chapter three.
-
Not SyncedDown here,
are the lower-valued uses -
Not Syncedof the good.
-
Not SyncedThis is the rubber ducky,
was down here. -
Not SyncedNow, at the controlled price
of one dollar, -
Not SyncedQs units are going to be supplied.
-
Not SyncedGiven that Qs units
are going to be supplied, -
Not Syncedthe most valuable uses
for those units -
Not Syncedare these uses up here.
-
Not SyncedThese are the high-valued uses.
-
Not SyncedIn a free market, these uses
or users would outbid -
Not Syncedthe other uses.
-
Not SyncedGoods would flow
from the low-valued uses -
Not Syncedto the high-valued uses,
and these would end up -
Not Syncedbeing the uses
which would be supplied -
Not Syncedin a free market.
-
Not SyncedHere's the key point --
the price control -
Not Syncedprevents the highest-valued uses
from outbidding -
Not Syncedthe lower-valued uses.
-
Not SyncedAs a result, some oil
will flow to lower-valued uses. -
Not SyncedIn other words, as a result
of the price control, -
Not Syncedsome rubber duckies
will end up being produced -
Not Syncedeven when we don't have enough oil
to fly jet aircraft. -
Not SyncedThese uses or users
will not be able to outbid -
Not Syncedthese guys down here
because of the price control, -
Not Syncedbecause the price is limited
to one dollar. -
Not SyncedBy the way, these guys
have the really low-valued uses, -
Not Syncedbut they're not even willing
to pay the controlled price. -
Not SyncedThey're not even being willing
to pay the dollar, -
Not Syncedso they won't get any oil at all,
which is a good thing, -
Not Syncedbecause they have
very low-valued uses. -
Not SyncedOn the other hand,
the high-valued uses, -
Not Syncedthey're not going to be able
to outbid these guys, -
Not Syncedso some of the oil
is going to be misallocated. -
Not SyncedIt's going to go to low-valued uses
even when there's not enough -
Not Syncedto satisfy all
of the highest-valued uses. -
Not SyncedThe most important point
is the one I just gave -- -
Not Syncedthat with price controls
prices no longer serve -
Not Syncedtheir signaling
and incentive function, -
Not Syncedand as the result, we get
the misallocation of resources. -
Not SyncedResources no longer flow
from their high-valued uses -
Not Syncedto their low-valued uses,
and as a result of that, -
Not Syncedwe get less use
out of our resources. -
Not SyncedWe get less value
from our resources. -
Not SyncedI want to show also,
that you can use the diagram -
Not Syncedto quantify this a little bit,
to show this on a diagram. -
Not SyncedLet's ignore the wasteful time
in search costs from price control, -
Not Syncedand what we want to do
is to compare -
Not Syncedthe maximum consumer surplus
given Qs, given Qs is supplied, -
Not Syncedwith a loss under, say,
random allocation. -
Not SyncedSo suppose that any use
which is willing to pay -
Not Syncedthe controlled price
is equally likely to be allocated -
Not Synceda unit of the good, in this case,
a unit of the gasoline. -
Not SyncedHow much will that reduce value?
-
Not SyncedHow much will that reduce
total consumer surplus? -
Not SyncedLet's take a look
at how to do this. -
Not SyncedLet's just remind ourselves
that if the gasoline goes -
Not Syncedto the highest-valued uses,
that is there are Qs units, -
Not Syncedand if these Qs units were to flow
to the highest-valued uses, -
Not Syncedthen consumer surplus
would be given by the area -
Not Syncedunderneath the demand curve
above the price. -
Not SyncedSo it would be given
by this green area. -
Not SyncedThis is the maximum
consumer surplus available -
Not Syncedfrom Qs units.
-
Not SyncedThis is the way we would get
the most out of these Qs units. -
Not SyncedWe would get the most value
by allocating it -
Not Syncedto the highest-valued units,
-
Not Syncedand then the total consumer
surplus created -
Not Syncedwould be this amount right here.
-
Not SyncedLet's now compare
with random allocation. -
Not SyncedBecause the good
is not necessarily allocated -
Not Syncedto the highest valued uses
with a price control, -
Not Syncedconsumer surplus
is going to be less -
Not Syncedthan the amount
which we just showed. -
Not SyncedHow much less?
-
Not SyncedLet's do some calculations,
and to do that -
Not Syncedto build our intuition,
we're going to consider -
Not Syncedhow one gallon of gasoline
might be allocated -
Not Syncedunder the best and worst conditions
for random allocation. -
Not SyncedSo we're going to take
one gallon of gasoline, -
Not Syncedand we're going
to allocate it randomly. -
Not SyncedSuppose we were really lucky.
-
Not SyncedWhat's the best case
for random allocation? -
Not SyncedSuppose we're really unlucky.
-
Not SyncedWhat's the worst case
for random allocation? -
Not SyncedLet's take a look.
-
Not SyncedThe best case scenario
for random allocation, -
Not Syncedis that this one gallon
of gasoline goes to the buyer -
Not Syncedwith the highest-valued use.
-
Not SyncedWhich buyer is that?
It's this buyer up here. -
Not SyncedIn that case, four dollars
of value is created, -
Not Syncedand consumer surplus
is three dollars. -
Not SyncedThe four dollar of value created
minus the one dollar for the price. -
Not SyncedWhat's the worst case?
-
Not SyncedThe worst case scenario,
is that the buyer -
Not Syncedwith the lowest-valued uses
randomly ends up with the good, -
Not Syncedwith the gallon of gasoline.
-
Not SyncedIn that case, the value created
is one dollar. -
Not SyncedThis is the buyer
with the lowest-valued use, -
Not Syncedbut this buyer's still willing
to pay the controlled price. -
Not SyncedSo that's one dollar
of value created -
Not Syncedor consumer surplus of zero.
-
Not SyncedIt costs them a dollar.
-
Not SyncedThey get something
which is worth a dollar to them. -
Not SyncedSo the consumer surplus is zero.
-
Not SyncedThose are the best and worst cases
for randomly allocating -
Not Syncedone gallon of gasoline.
-
Not SyncedUsing that intuition, let's look
at a scenario -
Not Syncedwhere a gallon of gasoline
is randomly allocated -
Not Syncedwith equal probability to any user
who is willing to pay -
Not Syncedthe controlled price.
-
Not SyncedThat is the gallon of gasoline
is randomly allocated -
Not Syncedto any user between $4 and $1
with a value between $4 and $1. -
Not SyncedIn this case,
because it's an equal probability, -
Not Synceda uniformed distribution,
the average value, -
Not Syncedturns out we
can calculate it easily, -
Not Syncedit's just one half
times the maximum $4, -
Not Syncedplus one half the minimum
possible value, which is $1. -
Not SyncedThe average use to which gasoline
will be put will be $2.50. -
Not SyncedLet's in fact put that
on the diagram. -
Not SyncedWhen the good is randomly allocated
to any user between a value -
Not Syncedof $4 and $1, the average use
will have a value of $2.50. -
Not SyncedThat means
that the consumer surplus -
Not Syncedis this green area right here --
-
Not Syncedthe difference
between the average value -
Not Syncedand the controlled price.
-
Not SyncedHere's the key point.
-
Not SyncedRemember, earlier we showed
that the maximum value -
Not Syncedwould have been the area underneath
the highest-valued users, -
Not Syncedunderneath the demand curve
for the highest-valued users, -
Not Syncedup to the quantity supplied.
-
Not SyncedThe maximum value,
the maximum consumer surplus -
Not Syncedfrom Qs units,
if all those Qs units -
Not Syncedwent to the highest-valued users,
is the red plus the green. -
Not SyncedWhen the gasoline
is instead allocated randomly, -
Not Syncedsometimes it goes
to a high-valued user, -
Not Syncedbut sometimes it goes
to a low-valued user. -
Not SyncedThen on average, the value
of that gasoline is less. -
Not SyncedWe get less value
out of that gasoline -
Not Syncedwhen it is allocated randomly
than when it is allocated -
Not Syncedby the price system.
-
Not SyncedAs a result, consumer surplus
is considerably lower -
Not Syncedunder random allocation
than it is when it's allocated -
Not Syncedby the price system,
which maximizes -
Not Syncedthe consumer surplus.
-
Not SyncedThat's just a diagrammatic way
of illustrating our first example -
Not Syncedof what happens when we don't have
the price system. -
Not SyncedOil no longer flows
from its low-valued uses -
Not Syncedto its high-valued uses,
so we get less value -
Not Syncedfrom the same resources.
-
Not SyncedThe resources become worth less
than they were before, -
Not Syncedbecause they're no longer allocated
to the highest-valued uses. -
Not SyncedWe've now covered
all the five important effects -
Not Syncedof price controls: shortages,
reductions in product quality, -
Not Syncedwasteful lines
and other search costs, -
Not Synceda loss in gains from trade,
and a misallocation of resources. -
Not SyncedNext, we're going to apply
all of these ideas to rent control. -
Not SyncedSince we understand the ideas,
-
Not Syncedwe should move
through that fairly quickly. -
Not SyncedAnd then we're going
to look at price floors. -
Not SyncedWhat happens
when the government says -
Not Syncedyou cannot sell a good
for less than a certain amount? -
Not Synced- [Narrator] If you want
to test yourself, -
Not Syncedclick "Practice Questions."
-
Not SyncedOr, if you're ready to move on,
just click "Next Video." -
Not Synced♪ [music] ♪
- Title:
- Price Ceilings: Misallocation of Resources
- Description:
-
Suppose there is a mild winter on the West Coast and a harsh winter on the East Coast. As a result of the weather, people on East Coast will demand more home heating oil, bidding up the price. Under the price system, entrepreneurs will be incentivized to take oil from where it has lower value on West Coast to where it has higher value on the East Coast. But when price controls are in place, even though the demand is still there from the East Coast, there is no signal of a higher price, eliminating the incentive for entrepreneurs to transport oil from west to east. In fact, this happened in the 1970s, resulting in oil going to lower valued uses on the West Coast while many people on the East Coast didn’t have enough oil to heat their homes. In this video, we’ll look at a diagram to visualize this misallocation of resources.
Microeconomics Course: http://mruniversity.com/courses/principles-economics-microeconomics
Ask a question about the video: http://mruniversity.com/courses/principles-economics-microeconomics/price-ceiling-misallocation-of-resources#QandA
Next video: http://mruniversity.com/courses/principles-economics-microeconomics/rent-controls-economics
- Video Language:
- English
- Team:
- Marginal Revolution University
- Project:
- Micro
- Duration:
- 11:49
Marilia_PM edited English subtitles for Price Ceilings: Misallocation of Resources | ||
Martel Espiritu edited English subtitles for Price Ceilings: Misallocation of Resources | ||
Martel Espiritu edited English subtitles for Price Ceilings: Misallocation of Resources | ||
Martel Espiritu edited English subtitles for Price Ceilings: Misallocation of Resources | ||
MRU2 edited English subtitles for Price Ceilings: Misallocation of Resources | ||
MRU2 edited English subtitles for Price Ceilings: Misallocation of Resources | ||
MRU2 edited English subtitles for Price Ceilings: Misallocation of Resources |