Prices

Lesson 18: Upsetting the Rules - Costs & Benefits of Government Price Controls

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Rent-Seeking Behavior

• Rent-seeking behavior refers to actions taken to preserve positive profits.

• A rational owner would be willing to pay any amount less than the entire green rectangle to prevent those positive profits from being eliminated as a result of entry.

Rent Seeking, Politics,and Elasticities

• Rent seeking – activities designed to transfer surplus from one group to another.

• Public choice economists integrate economic analysis of politics with their analysis of the economy.

• They argue that when all rent seeking and tax consequences are netted out, there is often not a net gain to the public.– Price Controls– Product Controls

Rent Seeking and Politics• Price controls reduce total producer and consumer surpluses• Individuals spend money to lobby governments to institute

policies that increase their own surplus• Governments institute them because people care more about

their own surplus than about total surplus• This is NOT capitalism• This is “Crony Capitalism” aka Crapitalism

Some “bad” examples:

Solyndra, LLC $535 million16+ assorted “green” industries $10 billion+Southern Co, Georgia electric conglomerate, $3.4 billionExport-Import Bank, $12 billion (Boeing)Boeing jets sale to Saudi ArabiaBank bailouts100 registered lobbyists of large corporations used to be staff members of the “Super Committee”GE $32 billion in defense contracts (8 GE lobbyists used to work for “Super Committee”

Product Controls

• Government regulates the type, amount, or quality of a produced G or S– Licensing– Pasteurized milk– Alcohol sales after 9pm– Blue Laws

Floors and Ceilings

Government interference with the market.

Price Floors• A price floor is a government-set price above equilibrium price, a

legal minimum price.•It is a tax on consumers and a subsidy to producers.•Price floors transfer consumer surplus to suppliers.• An example is the minimum wage or farm price supports. • A price floor creates an excess supply or surplus.

Who is really helped?

Effects of Price Floors

Price FloorNow B+D+F is Producer Surplus

Consumer Surplus, A

C+E, Still Welfare loss

Don’t Forget the Surplus that was created as well.

A Price Floor

Price Ceilings•A price ceiling is a government-set price below market equilibrium price, a legal maximum price. • It is an implicit tax on producers and an implicit

subsidy to consumers.• An example is the rent controls. • A price ceiling creates a decrease in supply or

shortage.

Who is really helped?

Effects of Price Ceilings!

Price ceiling

Transferred to Consumers

Producer Surplus, lost D and E

Consumer Surplus, A,B, added D, lost C Welfare Loss, C+E

Don’t Forget the Shortage that was created as well.

Rent Controls

Study Questions LYE 17• 1. What is “mixed” in the term mixed economy?• 2. How can the quantity supplied of apartments fall, even

in the short run? Isn’t there a fixed number of apartment units at any given time?

• 3. How might price ceilings on gasoline impede the evacuation of a city in the path of an oncoming hurricane?

• 4. *How can minimum wage laws reduce the long-run demand (not just short-run quantity demanded) for labor?

• 5. How can a minimum wage actually hurt even the workers who stay on the job?

Price Floors and Elasticity of Demand and Supply

S

D

P

PF

PE

QD QS

The surplus created by a price floor is larger if demand and supply are elastic.

Surplus

P

PF

PE

QD QS

SDSurplus

The Long-Run/Short-Run Problem of Price Controls

• The problem of price controls worsen from the short run to the long run.

• In the long run, supply and demand tend to be much more elastic than in the short run.

• In the short run there will be small effects from the price controls.

• There will be huge effects in the long run.

The Long-Run/Short-Run Problem of Price Controls

• In the face of price controls, potential new competitors hate to enter the market thereby strangling supply.

• Vacancy rates drop as potential new renters scramble to find shrinking affordable housing.

• In the long-run, supply and demand tend to be much more elastic than in the short run.

• In the short run, when demand and supply are more inelastic, the effects of price controls are small.

• In the long run, with more elastic demand and supply, the shortages or surpluses are larger.

Long-Run and Short-Run Elasticities

D0

Price

P1

PE

Q2QE

Short run Supply

Long run Supply

D1

Q1 Q3

P2 Larger long-runelasticities resultin smaller priceincreases whendemand increases.

Given the following demand andsupply of pizza, find consumer and

producer surplus.

50 150100 200 250 300

$4

$5

$6

$7

$8

$9

$10

D

SConsumer Surplus: ½ x ($10-6) x 100 = $200

Producer surplus: ½ x ($6-4) x 100 = $100

Given the following demand and supply of pizza, show the effects of a

price floor at $8.

50 150100 200 250 300

$4

$5

$6

$7

$8

$9

$10

D

SConsumer Surplus

Producer surplus

Price Floor

Deadweight Loss

Government Intervention asImplicit Taxation

• Government intervention in the form of price controls can be viewed as a combination tax and subsidy.

• A price ceiling is an implicit tax on producers and an implicit subsidy to producers that causes a welfare loss identical to the loss from taxation.

• A price floor is a tax on consumers and a subsidy for producers that transfers consumer surplus to producers.

Readings and Assignments

• The Young Economist Chapters 17• Economic Reasoning Chapter 6

The Racism of King KongIn all three film versions of the basic story, we are led to believe that Kong regularly feasts on native girls. Female human sacrifice is how the locals appease him. Then, in each re-telling, he is transformed from mindless, blood-thirsty carnivore to smitten, suicidal love monkey by a skinny, blonde-haired white girl (Fay Wray, Jessica Lange, Naomi Watts). Given this behavioral trend, it is my contention that King Kong would eat Halle Berry. This troubles me deeply and I wanted to share it with you.