Lecture on Price Ceilings and Floors

Introduction

• Purpose of Lecture: Exploring the effects of price ceilings and floors.
  • Governments frequently impose these measures.
  • Importance of understanding the disruption of price signals.

Price Ceilings

• Definition: Maximum price allowed by law.
  • Example: Gasoline price ceiling at $2.50.
  • Legal restriction: Illegal to trade above this price.
• Effects of Price Ceilings:
  • Create shortages.
  • Reduce product quality.
  • Lead to wasteful lines and search costs.
  • Result in a loss of gains from trade (deadweight loss).
  • Cause misallocation of resources.

Shortages

• Explanation: Using supply and demand framework.
  • Market equilibrium: Quantity demanded equals quantity supplied.
  • Price ceiling below equilibrium leads to controlled price.
  • Outcome: Quantity demanded exceeds quantity supplied = Shortage.
• Market Dynamics:
  • Normally, prices would rise to eliminate shortage.
  • Under ceiling, price cannot adjust, and shortage persists.

Examples of Shortages

• Seller Behavior:
  • More customers than goods.
  • Sellers do not need to compete for customers.
• Impact on Quality:
  • Reduction in quality to cut costs.
  • Historical examples: 1970s product quality decline.
    • Lower quality paper, thinner lumber, fewer coats of paint.
  • The "Great Matzo Ball Debate": Reduction in matzo balls in soup.

Service and Customer Experience

• Service Quality:
  • Reduced incentive for good service when shortage exists.
  • Example: Disappearance of full-service gas stations in 1973.
• Customer Treatment:
  • More customers than needed can lead to unpleasant service.
  • Comparative Examples:
    • DMV vs. Starbucks: Lack of competition affects service.
    • Communist stores vs. McDonald's: Incentive to attract customers affects employee behavior.

Conclusion

• Key Effects of Price Ceilings:
  • Shortages and reductions in product quality reviewed.
  • Upcoming topics: Wasteful lines and search costs, loss of trade gains, misallocation of resources.

Next Steps

• Opportunity to test with practice questions or proceed to the next part.