Lecture Notes: Government Intervention and Price Controls

Overview

• Second lecture on government intervention, focusing on price controls.
• Discusses price ceilings and floors, their effects, and related real-world examples.

Price Ceilings

• Definition: Maximum legal price at which a good can be sold.
• Binding Price Ceiling: Maximum price set below equilibrium price, affecting market outcomes.
  • Example: Gasoline price ceiling of $500/gallon is non-binding if market price is lower.
• Examples of Binding Price Ceilings:
  • US gasoline prices in the 1970s
  • Ticket resale laws
  • Rent control in housing markets

Effects of Price Ceilings

• Market Shortages: When price ceiling is below equilibrium, demand exceeds supply.
  • Example: At a price ceiling of $1.50, supply is 20 units, demand is 30 units, shortage of 10 units.
• Real-World Consequences:
  • Queuing and waiting lines (e.g., 1970s gas lines)
  • Secondary markets (e.g., reselling Nintendo Switch consoles at higher prices)
  • Bundling (e.g., selling event tickets with additional services)
  • Creative bypasses (e.g., offering parking at gas stations)

Rent Control

• Definition: A type of price ceiling applied to real estate.
• Negative Effects:
  • Reduction in quantity supplied (e.g., apartments converted to condos)
  • Lower housing turnover rates (e.g., New York City)
  • Deterioration and lack of investment in buildings
• Economist Consensus: Generally, economists agree that rent control laws reduce the amount and quality of affordable housing.

Price Floors

• Definition: Minimum legal price at which a good can be sold.
• Binding Price Floor: Minimum price set above equilibrium, affecting market outcomes.
  • Example: Minimum wage laws.
• Labor Market Implications:
  • Workers are suppliers of labor; firms are demanders.
  • Potential surplus of labor as fewer workers are hired at higher wages.
• Economist Views: Mixed opinions on the impact of minimum wage laws on employment.

The Role of Elasticity

• Inelastic Demand: Smaller reduction in labor demanded with wage increase.
• Elastic Demand: Larger reduction in labor demanded.
• Other Considerations:
  • Selection bias in hiring (e.g., preference for adults over teenagers)
  • Changes in job conditions (e.g., unpredictable hours, no paid breaks)

Policy Example: Organ Donation

• Current Situation: Illegal to sell organs, leading to a price ceiling of $0.
• Market Impact: Significant shortage in kidneys due to the price ceiling.
• Estimated Market Equilibrium Price: Around $115,000 for kidneys.

Conclusion

• Government intervention through price controls can lead to unintended consequences such as shortages and reduced quality.
• Economists generally prefer less distortion in price signals for more efficient market outcomes.