Price Supports Here are two examples of government intervention in a market.
Word association game I’ll say a word and I want you to look at the word I say. You better play because I’ll know if you don’t. Left hand Ceiling Right foot Floor. Very good class! Now, in economics when we say ceiling and floor we want you to think differently.
Price Ceilings and Price Floors Price ceilings and price floor are government price “supports” that occur mainly because folks have indicated there is something about the market price that they do not care for. Typically this dislike is that the price is too high or too low. When you walk in a room you stand with the floor below and the ceiling up. BUT, when you stand at the market price the floor has to be above and the ceiling below. Let’s see why.
price floor The downward arrow is here to suggest price can not get below Pf. P S1 A price floor is a minimum legal price. The government enacts one when it is felt the market price is too low. So an effective legal minimum must be above the equilibrium price so price can not get down to the unwanted P1. Pf a b c d e P1 D1 Q Qs Qd Q1 Look up for the floor!
price floor With the price floor we see, in comparison to the normally functioning market: 1) higher price Pf, 2) lower quantity demanded - from Q1 to Qd. 3) Higher quantity supplied - Q1 to Qs. 4) surplus = Qs - Qd. 5) A lower amount traded - Qd. The amount traded has fallen because sellers can only sell what buyers buy.
price floor One thing we notice with the floor is a surplus is created. What happens to the goods that are made and not purchased? Maybe the government will buy them – the government would have to pay (Qs – Qd)times Pf to buy the surplus. Maybe the government will ask producers not to make them.
price ceiling P A price ceiling is a maximum legal price. The government enacts one when it is felt the market price is too high. So an effective legal maximum must be below the equilibrium price. Price can then not legally get to the unwanted P1. S1 P1 Pc D1 Q The upward arrow is here to suggest price can not get above Pc. Qd Qs Q1 Look down for the ceiling
price ceiling With the price ceiling we see: 1) lower price Pc, 2) lower quantity supplied - from Q1 to Qs. 3) Higher quantity demanded - Q1 to Qd. 4) shortage = Qd - Qs. 5) A lower amount traded Qs. The amount traded has fallen because buyers can only buy what sellers sell.
price ceiling P This screen is a repo of a previous screen. Imagine you are sitting at P1, do it! Where do you look for the ceiling? Down! Why not up? A ceiling above P1 would cause a surplus and we know with a surplus the price will fall. It would fall to P1. S1 P1 Pc D1 Q The upward arrow is here to suggest price can not get above Pc. Qd Qs Q1 Price ceilings above equilibrium are not binding Or are not effective!
Eliminating a price support? What would happen if enough people got sick up and feed (you know, feeling ill) with price supports and had them eliminated? What would happen in the market? If there was a price floor then the quantity demanded would rise and the quantity supplied would fall and supply and demand would meet at the new lower price. If there was a price ceiling then the quantity demanded would fall and the quantity supplied would rise and supply and demand would meet at the new higher price.