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Price Controls and Quotas

Lecture 5

Markets will tend towards competitive equilibrium.

Refresher and Moving Forward

Markets will tend towards competitive equilibrium.
That equilibrium is stable.

Refresher and Moving Forward

Markets will tend towards competitive equilibrium.
That equilibrium is stable.
Certain policies can prevent the adjustment to that equilibrium from occurring.
  • Price floors and price ceilings.
  • Quotas.
Policies that Prevent Adjustment
Price controls: legally mandated maximum or minimum prices that can be charged.
  • Maximum = price ceiling
  • Minimum = price floor
Quotas: a maximum amount that can be produced or sold.

A Market at Equilibrium

Q P D S PEQ QEQ

Price Ceilings

A price ceiling is set below the equilibrium price.
Q P D S PEQ QEQ PCeiling QS

Price Ceilings Cause Shortages

Price ceilings cause QS to be less than QEQ.
In such a case, Q = QS.
There is a shortage (excess demand).
Q P D S PEQ QEQ PCeiling QS=Q QD shortage

Price Ceilings Create Deadweight Loss

Total surplus is now smaller: there is a deadweight loss.
The shaded area represents mutually beneficial trades that would have occurred without the ceiling.
Q P D S PEQ QEQ PCeiling QS=Q DWL

Who stands to benefit from price ceilings?

Some consumers who get to buy the good at a lower price.

Who stands to benefit from price ceilings?

Some consumers who get to buy the good at a lower price.
At whose expense?
  • Producers.
  • Other consumers who don’t get the good at all.
Manhattan Institute Issue Brief, Rent Control Does Not Make Housing More Affordable
“Rent regulations ‘solve’ America’s affordability crisis for a few people, for a short time, at great cost to everyone else. Tenants in controlled units do often see lower rents. But those who are not in controlled units experience higher costs as the available housing supply shrinks. The result is a tale of two cities, divided between the rent-controlled and the non-rent-controlledthe housing winners and the housing losers. Ultimately, rent control’s restrictions on housing harm low-income, minority, and immigrant Americans most of all.” Manhattan Institute Issue Brief, 2020
The economic logic: Price ceilings help the lucky few who get the good. They harm producers and the unlucky many who are rationed out. Rent control is a textbook price ceiling applied to housing.

Emergency Room Services

Who stands to benefit from keeping emergency room services priced lower-than-market?
  • Some patients who get services at a lower price.
At whose expense?
  • Hospitals and medical professionals.
  • Other patients who don’t get the services at all (or have to wait a long time).

Price Floors

A price floor is set above the equilibrium price.
Price floors cause QD to be less than QEQ.
In such a case, Q = QD. There is a surplus (excess supply).
Q P D S PEQ QEQ PFloor QD=Q QS surplus

Price Floors Create Deadweight Loss

Total surplus is now smaller: there is a deadweight loss.
Q P D S PEQ QEQ PFloor QD=Q DWL

Who stands to benefit from price floors?

Some producers who get to sell the good at a higher price.
At whose expense?
  • Consumers.
  • Other producers who don’t get to sell the good at all.

Minimum Wage Laws

Who stands to benefit from minimum wage laws?
Some workers who are employed and receive a higher wage than they otherwise would have.
Q W D S WEQ QEQ WMin QD=Q QS

Minimum Wage Laws

Some workers who are employed receive a higher wage.
At whose expense?
  • Employers.
  • Other workers who would have been employed at WEQ but are now not.
“Fight for $15”, McDonald’s to Place Automated Ordering Stations at all US Locations
“McDonald’s has announced plans to roll out automated kiosks and mobile pay options at all of its U.S. locations, raising questions about the future of its 1.5 million employees in the country and around the globe. The locations that are seeing the first automated kiosks closely correlate with the fight for a $15 minimum wage. New York state in 2016… Florida’s minimum wage will rise Jan. 1, 2017. Seattle raised its minimum wage to $15 in 2014, followed by San Francisco and Los Angeles.” The Daily Caller, November 2016
The economic prediction: When the price of labor rises above equilibrium, employers substitute toward capital (machines). This is exactly what the model predicts.

What happens when policies prevent price rationing?

What happens when policies prevent price rationing?

The primary margin for rationing scarce goods is price.
Scarcity is a fact, we have to ration somehow.
If price is taken away, other margins emerge.
  • Religion? Race? Gender? Sexual preference? Ethnicity?
  • Discrimination becomes cheaper when price controls remove its cost.
Forbes, “Unintended Consequences”, Art Carden, September 2011
“In a market that is left to its own devices, everyone who wants an apartment at the market price gets one, and everyone who is willing to rent out an apartment at the market price finds a tenant. When the price is held below what the market will bear, landlords can be choosier about who they take on as tenants. In a free and competitive market, a bigoted landlord would at least have to pay for his bigotry in the form of lower profits. It’s also likely that these lower profits would ultimately encourage him to find another line of work. When rents are controlled, the penalty for bigotry is effectively removed.” Forbes, Art Carden, September 2011
On the Historically Racist Motivations Behind Minimum Wage, Forbes, April 2014
“Senators are expected to vote tomorrow on a bill that would raise the minimum wage from $7.25 to $10.10, a well-intentioned though economically irrational policy change that few Democrats realize has a troubling racial history. The 1931 Davis-Bacon Act, requiring ‘prevailing’ wages on federally assisted construction projects, was supported by the idea that it would keep contractors from using ‘cheap colored labor’ to underbid contractors using white labor.” Forbes, April 2014
Thomas Sowell, Hoover Institution, Stanford University
“In 1925, a minimum-wage law was passed in the Canadian province of British Columbia, with the intent and effect of pricing Japanese immigrants out of jobs in the lumbering industry. A Harvard professor of that era referred approvingly to Australia’s minimum wage law as a means to ‘protect the white Australian’s standard of living from the invidious competition of the colored races, particularly of the Chinese’ who were willing to work for less.” Quoted in Forbes, April 2014
The economic insight: When price controls eliminate the cost of discrimination, history shows that non-price discrimination flourishes.

Quotas Have the Same Effect as a Price Floor

At any P < PQuota, buyers want to purchase more than the quota.
Sellers will charge the highest P consistent with selling the entire quota (PQuota).
Q P D S PEQ QEQ Quota=Q PQuota

Who stands to benefit from quotas?

Some producers who get to sell the good at a higher price.
At whose expense?
  • Consumers.
  • Other producers who don’t get to sell the good at all.
AMA Policies as a Quota on Medical Licenses
“Health professionals often cite a need for more doctors. Last year, a study released by the Association of American Medical Colleges warned of the ‘looming physician shortage’ and the need for more doctors. The American Medical Association, the country’s largest association of physicians, emphasizes the importance of getting more government funding for physician residencies. But before evaluating these recommendations, policymakers should recognize that doctors are a big part of the reason we’re in this mess. For decades, physicians associations have had an anti-competitive stranglehold on healthcare.” Washington Examiner, January 3, 2018
The economic analysis: Licensing requirements that restrict the number of practitioners function as a quotabenefiting licensed practitioners at the expense of consumers and unlicensed applicants.

If price controls & quotas reduce total surplus, why do they exist?

If price controls & quotas reduce total surplus, why do they exist?

They create benefits for some by imposing larger-than-offsetting losses on others.
The benefits are concentrated while the costs are dispersed.
Also, benefits are often visible while costs are harder to detect.
  • When the minimum wage rises, we see workers earning more, but not the jobs that aren’t created or refilled.
The Sugar Quota: A Case Study in Concentrated Benefits
In 2022, Americans consumed about 11.3 million metric tons of sugar.
Due to sugar quotas, we pay about 10 cents per pound over the world market price.
That’s consumers paying about $2.5 billion extra for sugar!
That’s only about $7.50 per capita (given 331 million people)
but there are about 4,000 sugar farms in the US, so it’s a transfer from consumers to producers of about $625,000 per sugar farm.
The political economy: Each consumer loses $7.50not worth organizing against. Each farm gains $625,000very much worth lobbying for.

What is an elasticity?

Elasticities

An elasticity is a statement of the percentage change in some variable that is associated with a 1 percent change in another variable.
Useful because they are unit invariant.
  • E.g., “If you raise the minimum wage by $1, low-skilled employment will decrease by 10,000 workers”is that a big effect? Depends on whether the wage was $5 or $50, and whether we’re considering Lubbock or the entire US.
Price Elasticity of Demand
Price Elasticity of Demand = %Δ(QD) / %Δ(P)
Since a demand curve plots QD against P, when we refer to “the elasticity of demand” we mean, unless otherwise specified, its price elasticity.

Other Elasticities

Income Elasticity of Demand
  • %Δ(QD) / %Δ(Income)
Wage Elasticity of Labor Demand
  • %Δ(Employment) / %Δ(Wage)
  • Central to the minimum wage debate.

Price Elasticity of Demand: Shape of Curve

More elastic demand (larger |%ΔQ / %ΔP|) ︎→︎ flatter demand curve.
  • Consumers are very responsive to price changes.
Less elastic demand (smaller |%ΔQ / %ΔP|) ︎→︎ steeper demand curve.
  • Consumers are less responsive to price changes.

Perfectly (Price) Inelastic Demand

No matter how much price changes, quantity demanded does not change.
Elasticity = %Δ(QD) / %Δ(P) = 0 / %Δ(P) = 0
Q P D

Perfectly (Price) Elastic Demand

Any price increase causes quantity demanded to fall to zero.
Elasticity ︎→︎ −∞
Q P D
Coffee Price Example
A coffee shop currently sells 10,000 large coffees at $2.20 each.
Initial revenue: $22,000.
The shop is considering raising the price to $2.50.
How will this price change affect revenue?

Coffee Price Example: Two Opposing Effects

On the one hand, people will now pay more for each large coffee they buy.
On the other hand, some people on the margin will decrease the amount they buy.
Which effect dominates depends on the price elasticity of demand.
Coffee Price Example: Elastic vs. Inelastic
Initial: Q = 10,000  |  P = $2.20  |  Revenue = $22,000
Price rises to $2.50
Scenario New Q New Revenue Revenue Change
Elastic demand, Q falls a lot 5,000 $12,500 –$9,500
Inelastic demand, Q falls a little 9,500 $23,750 +$1,750
When demand is elastic, a price increase reduces revenue. When demand is inelastic, a price increase raises revenue.
Calculating the Price Elasticity of Demand
Elasticity = %Δ(QD) / %Δ(P)
Elastic case: (−5,000/10,000) / (0.30/2.20) = −0.50 / 0.136 ≈ −3.67
Inelastic case: (−500/10,000) / (0.30/2.20) = −0.05 / 0.136 ≈ −0.37
|Elasticity| > 1 ︎→︎ elastic,   |Elasticity| < 1 ︎→︎ inelastic.

Minimum Wage and Wage Elasticity of Labor Demand

Some debate about the minimum wage focuses on the wage elasticity of labor demand.
Scenario A: low-skilled employment decreases by 1% while the remaining 99% of jobs pay 10% more.
Scenario B: low-skilled employment decreases by 10% while the remaining 90% of jobs pay 1% more.
Who benefits and who pays depends crucially on the elasticity of labor demand.

Interactive: Price Ceiling & Floor

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Interactive: Elasticity and Revenue

Elastic Demand
Inelastic Demand
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Key Terms

Practice Questions
Question 1 of 5

Thanks for your attention!