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Summary Chapter 6 - Supply, Demand, and Government Policies
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Chapter 6 - Supply, Demand, and Government PolicesControl on Prices
How Price Ceilings Affect Market Outcomes
When the government imposes a price ceiling on the market there are two possible
outcomes. If the price ceiling imposed is above the market equilibrium, there will be no effect
on supply and demand because the price ceiling is above equilibrium. This makes the price
ceiling not binding. The other possibility is that if the price ceiling is below the market
equilibrium the ceiling is a binding constraint, on the market. The forces of supply and
demand tend to move the price toward the equilibrium price, but when the market price hits
the ceiling, it can't rise any further. Thus the market price = market ceiling. This will then
create a shortage of the good. When a shortage develops because of a price ceiling, some
mechanism for rationing will naturally develop. The mechanism could be along the lines:
buyers who are willing to arrive early and wait in line will get the good or service.
Alternatively, sellers could ration goods according to their own personal biases. Notice that
even though the price ceiling was motivated by a desire to help buyers, not all buyers benefit
from the policy. Some buyers will get to pay a lower price, although they might have to wait
in line, but some buyers will not get a chance to buy the good at all. The rationing
mechanisms that develop under price ceilings are rarely desirable. Long lines are inefficient
because they waste buyers’ time. Discrimination according to sellers bias is both inefficient
and potentially unfair. By contrast, the rationing mechanism in a free, competitive market is
both efficient and impersonal. When the market reaches its equilibrium, anyone who wants
to pay the market price can get goods. Free markets ration goods with prices.
How Price Floors Affect Market Outcomes
Price floors, like price ceilings, are an attempt by the government to maintain prices at other
than equilibrium levels. Whereas a price ceiling places a legal maximum on prices, a price
floor places a legal minimum. When the government imposes a price floor, two outcomes are
possible. If the government imposes a price floor below the market equilibrium the price floor
will have no effect on the market and is nonbinding. The other outcome is that the price floor
is placed above the market equilibrium, in which the price floor is a binding constraint on the
market. The forces of supply and demand will try to move the price to the equilibrium but will
then be stopped at the price floor. The market price = price floor. At this floor, the quantity
supplied will exceed the quantity demanded. Some people who want to sell at the going
price are unable to. Thus, a binding price floor causes a surplus. Just as price ceilings and
shortages can lead to undesirable rationing mechanisms, so can price floors and surpluses.
In the case of a price floor, some sellers are unable to sell all they want at the market price.
The sellers who appeal to the personal biases of the buyers, perhaps due to racial or familial
ties, are better able to sell their goods than those who do not. By contrast, in a free market,
the price serves as the rationing mechanism, and sellers can sell all they want at the
equilibrium price.
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