Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Module 10 krugman 1
Module 10
Price Controls (Ceilings and Floors)
What’s New in the Fourth Edition?
• Updated case studies
Module Objectives
• What is a market intervention and why are price controls the main forms it takes?
• Why do price controls create deadweight losses?
Teaching Tips
Price Ceilings
Creating Student Interest
• Ask students if they think a cap (price ceiling) on tuition is a good idea. Discuss how a tuition
maximum might affect quantity demanded, quantity supplied, and the quality of classes at their
school. Another possibility is to ask the students if they think a price ceiling on gasoline is a good
idea.
Presenting the Material
• Students will not usually have difficulty grasping the concept of a price ceiling, but they may struggle
with graphically illustrating the effects of the price ceiling. Start with a simple example using the
following table, which should be familiar from Module 5.
Rent
Quantity demanded
(units rented per month)
Quantity supplied
(units for rent monthly)
$1,400
1,000
2,000
1,200
1,100
1,500
1,000
1,200
1,200
800
1,500
1,000
600
1,800
750
400
2,100
600
1. If a price ceiling of $800 is set on apartment rentals, how much of a shortage is created?
2. How would this shortage manifest itself in the market? (In the short run, many renters
Module 10 krugman 2
Price Floors
Creating Student Interest
• Ask the class if anyone knows how much the federal minimum wage is. Ask the class if anyone is
(or ever has, or knows someone who is) earning the minimum wage. What about a wage above the
minimum wage? Below it? (Be careful here—many college students have jobs waiting tables at
Presenting the Material
• As with the price ceiling, students will usually be able to grasp the concept of a price floor, but will
struggle with the graph. Start with the table below and then illustrate the effects of the price floor
graphically. Once you have identified quantity demanded and quantity supplied on your graph, you
can identify the deadweight loss.
Wage
Quantity of
labor demanded
Quantity of
labor supplied
$6.75
300
500
6.00
400
400
5.75
500
300
5.50
550
200
5.00
600
100
4.75
650
50
2. If a price floor is set at $6.75 (minimum wage), how much of a surplus of unemployed
Common Student Pitfalls
• Ceilings, Floors, and Quantities A price ceiling pushes the price of a good down. A price floor
pushes the price of a good up. So it’s easy to assume that the effects of a price floor are the opposite
Module 10 krugman 3
of the effects of a price ceiling. In particular, if a price ceiling reduces the quantity of a good bought
and sold, doesn’t a price floor increase the quantity?
No, it doesn’t. In fact, both floors and ceilings reduce the quantity bought and sold. Why? When the
quantity of a good supplied isn’t equal to the quantity demanded, the actual quantity sold is
Module Outline
Opening Example: Rent control and taxi licenses are given as examples of what happens when the logic
of the market is defied by government intervention.
I. Why Governments Control Prices
A. Price controls are enacted by governments in response to political pressures from buyers and
sellers.
II. Price Ceilings
A. Modeling a price ceiling: A price ceiling is set below the equilibrium price. A price ceiling set
above the equilibrium price has no effect. This is illustrated in text Figure 10-2, shown below.
B. A price ceiling set below the equilibrium price creates a shortage.
Figure 10-2
C. A price ceiling causes inefficiency because it:
1. Causes a deadweight loss.
Module 10 krugman 4
2. Inefficiently allocates to consumers who have a lower willingness to pay and keeps
people who would be willing to pay a higher price from receiving the good.
3. Causes people to spend resources dealing with a shortage.
4. Causes sellers to offer low-quality goods at a low price even though buyers would prefer
a higher quality at a higher price.
D. Price ceilings lead to black markets.
E. Price ceilings are enacted because:
1. They do benefit some people.
III. Price Floors
A. Price floors lead to excess supply; the quantity supplied is greater than quantity demanded at
the set price. Price floors are ineffective if set below the equilibrium price.
B. Modeling a price floor: A price floor is set at a price that is above the equilibrium price. This
is illustrated in text Figure 10-5, shown here.
Figure 10-5
C. A price floor causes inefficiency because it:
1. Results in a quantity below the efficient level. Since a price floor raises the price of a
good to consumers, quantity demanded falls, so the quantity bought and sold falls,
creating deadweight loss.
Module 10 krugman 5
4. Causes the production of goods of inefficiently high quality.
5. Results in illegal activity.
F. Government officials often disregard warnings about the consequences of price floors, either
because they believe that the relevant market is poorly described by the supply and demand
model or, more often, because they do not understand the model.
Case Studies in the Text
Economics in Action
The Rise and Fall of the Unpaid Intern—This EIA discusses the rising popularity of unpaid internships.
Ask students the following questions:
1. Is the minimum wage binding for interns? How do you know? (Yes, because there are many
Web Resources
Module 10 krugman 6
Handout 10-1
Date_________ Name____________________________ Class________ Professor________________
Rent Control
What are the pros and cons of rent-control laws?
Pros
Cons
How is this issue an example of the trade-off between equity (fairness) and efficiency?
How do rent-control laws cause the “market to strike back”?
Module 10 krugman 7
Price Ceilings and Essential Goods
Consider the following situation: During the Northridge earthquake in Los Angeles County,
water was in short supply in the Valley and the price of bottled water skyrocketed. The city
invoked a state law that prohibits businesses from charging more than 5% extra for certain
“essential goods” within 30 days after a natural disaster.
Should a state be able to put price ceilings on “essential” goods following a natural disaster,
or should market prices prevail? What would be the result of such price ceilings?
Prescription Medications (15–30 minutes)
Analyze the pros and cons of putting price ceilings on prescription medicine.
Pros
Cons
