Transcript Price Ceilings and Price Floors - Choose your book for Principles of

Chapter 6
Price Ceilings and Price
Floors
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Economic Principles
Government intervention in markets
Price ceilings
Price floors
Parity pricing
Target prices
Crop limitation programs
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EXHIBIT 1 PRODUCTION POSSIBILITIES CURVE FOR
CIVILIAN AND DEFENSE GOODS
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Exhibit 1: Production Possibilities
Curve for Civilian and Defense Goods
The production possibilities
curve in Exhibit 1 provides
information on:
• The production possibilities curve shows
the possible combination of civilian and
defense goods that could be produced.
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Exhibit 1: Production Possibilities
Curve for Civilian and Defense Goods
When there is a national security
crisis, the number of civilian
goods produced:
• The production of civilian goods
declines as more defense goods are
produced.
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EXHIBIT 2 THE FISH MARKET BEFORE AND AFTER
THE DRAFT
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Exhibit 2: The Market Before and After
the Draft
In Exhibit 2, the community’s
predraft and postdraft demand
for fish does not change.
• Demand for fish doesn’t change just
because there’s a national security problem.
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Exhibit 2: The Market Before and After
the Draft
In Exhibit 2, the community’s
predraft and postdraft demand
for fish does not change.
• Note that the demand curves before and
after the supply curve has shifted are
identical.
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Exhibit 2: The Market Before and After
the Draft
After the draft, the quantity of
fish supplied:
• With fishermen being drafted and fewer
boats in the water, the supply of fish
declines and the supply curve shifts to the
left.
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Exhibit 2: The Market Before and After
the Draft
Postdraft, the equilibrium price
of fish:
• The equilibrium price of fish increases
from $4 to $10 after the draft.
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Exhibit 2: The Market Before and After
the Draft
After the draft, the quantity of
fish bought and sold:
• The quantity of fish bought and sold
declines from 10,000 to 7,000 fish.
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Exhibit 2: The Market Before and After
the Draft
The greater burden of the
increased price for fish is felt by:
• The poor
• The rich
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Exhibit 2: The Market Before and After
the Draft
The greater burden of the
increased price for fish is felt by:
• The poor
• The rich
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Exhibit 2: The Market Before and After
the Draft
The greater burden of the
increased price for fish is felt by:
• The increase in the price of fish makes it
unthinkable for the poor to purchase fish,
while the rich hardly notice the increase
and continue to buy fish.
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Price Ceiling
Price ceiling
• A maximum price set by government
below the market-generated equilibrium
price.
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EXHIBIT 3 SETTING A $4 PRICE CEILING IN THE
FISH MARKET
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Exhibit 3: Setting a $4 Price
Ceiling in the Fish Market
In Exhibit 3, when a $4 price
ceiling is set, the market for fish:
• When the price ceiling is set at $4, the
quantity of fish demanded increases
from 7,000 to 10,000.
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Exhibit 3: Setting a $4 Price
Ceiling in the Fish Market
In Exhibit 3, when a $4 price
ceiling is set, the market for fish:
• Based on the post-draft supply curve,
the quantity of fish supplied falls from
7,000 to 4,000.
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Exhibit 3: Setting a $4 Price
Ceiling in the Fish Market
In Exhibit 3, when a $4 price
ceiling is set, the market for fish:
• Based on the postdraft supply curve,
there is a shortage—an unsatisfied
excess demand—of 6,000 fish.
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Exhibit 3: Setting a $4 Price
Ceiling in the Fish Market
Allocate a shortage of goods:
• One method is through the use of
ration coupons.
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Exhibit 3: Setting a $4 Price
Ceiling in the Fish Market
Allocate a shortage of goods:
• Ration coupons are issued by the
government, entitling the holder to
purchase a specific quantity of a good at
or below the price ceiling.
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Exhibit 3: Setting a $4 Price
Ceiling in the Fish Market
Allocate a shortage of goods:
Ration coupons may be issued based on
schemes such as:
• First come, first served.
• Household size.
• Lottery.
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Price Ceiling and Housing
Rent control is a government-set
price ceiling on rent.
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Price Ceiling and Housing
Arguments against rent control:
• It dampens landlords’ incentives to
properly maintain their existing rental units.
• It discourages many people from
investing in new construction.
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Price Floors
Price floor
• A minimum price set by government
above the market-generated
equilibrium price.
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EXHIBIT 4 EFFECT OF NEW TECHNOLOGY ON
THE FISH MARKET
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Exhibit 4: Effect of New
Technology on the Fish Market
When a new technology is
adopted, the supply curve in the
fish market:
• The supply curve shifts the the right.
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Exhibit 4: Effect of New
Technology on the Fish Market
After adopting the new
technology, total revenue for the
fisherman:
• Total revenue decreases.
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Exhibit 4: Effect of New
Technology on the Fish Market
After adopting the new
technology, total revenue for the
fisherman:
• Prior to adopting the new technology,
10,000 fish were sold at an equilibrium
price of $4 each, for a total revenue of
$40,000.
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Exhibit 4: Effect of New
Technology on the Fish Market
After adopting the new
technology, total revenue for the
fisherman:
• After adopting the new technology,
12,000 fish are sold at an equilibrium
price of $2 each, for a total revenue of
$24,000.
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EXHIBIT 5 SETTING A $4 PRICE FLOOR IN THE
FISH MARKET
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Exhibit 5: Setting a $4 Price
Floor in the Fish Market
In Exhibit 5, when a $4 price
floor is set, the market for fish:
• The quantity of fish supplied increases
from 12,000 to 15,000.
• The quantity of fish demanded declines
from 12,000 to 10,000.
• A surplus, or excess supply, of 5,000 fish
is created.
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Exhibit 5: Setting a $4 Price
Floor in the Fish Market
The excess supply of fish can be
dealt with:
• The decision to support a price floor is a
societal matter.
• If the community represented by the
government wants to support the fishermen
through a price floor, then the
government will buy the excess supply.
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EXHIBIT 6 GROWTH OF U.S. AGRICULTURAL
PRODUCTIVITY THROUGHOUT U.S. HISTORY
* Precise data are not available.
Source: James Zelner and R.M. Lamm, “Agriculture’s Vital Role for Us All,” Food—From Farm to Table, 1982
Yearbook of Agriculture, Department of Agriculture, Washington, D.C., p. 3.
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Exhibit 6: Growth of US Agricultural
Productivity Throughout U.S. History
Agricultural productivity has
increased in the U.S. because:
• Changes in the dominant energy source
technology used on farms.
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Exhibit 6: Growth of US Agricultural
Productivity Throughout U.S. History
Agricultural productivity has
increased in the US because:
• Advances in modern chemistry to produce
fertilizers, insecticides, crop ripeners and
food preservatives.
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EXHIBIT 7 NUMBER AND SIZE OF U.S. FARMS
Source: Public Policy and the Changing Structure of American Agriculture, Congressional Budge Office, The
Congress of the United States, Washington, D.C., September 1978, p. 2; Agricultural Statistics, 1995–1996,
United States Department of Agriculture, Washington, D.C., 1996.
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Exhibit 7: Number and Size of U.S.
Farms
Since 1945, the average size of
U.S. farms:
• The average size of US farms has
steadily increased, from 195 acres in 1945
to 496 acres in 1995.
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Exhibit 7: Number and Size of U.S.
Farms
The number of farms in the U.S.:
• The number of farms has declined from
about 6 million in 1945 to about 2 million
by 1995.
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EXHIBIT 8 INDEXES OF TOTAL FARM OUTPUT: 1950–99
(1996 = 100)
Source: Economic Report of the President, 2003, Washington, D.C., p. 439.
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Exhibit 8: Indexes of Total Farm
Output: 1950-99 (1996 = 100)
Total farm output in the U.S.
between 1950 and 1999 almost:
• Fell by one-half
• Doubled
• Tripled
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Exhibit 8: Indexes of Total Farm
Output: 1950-99 (1996 = 100)
Total farm output in the U.S.
between 1950 and 1999 almost:
• Fell by one-half
• Doubled
• Tripled
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EXHIBIT 9 EFFECT OF NEW TECHNOLOGY IN FARMING
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Exhibit 9: Effect of New
Technology in Farming
As new energy source technologies
and modern chemistry increase
productivity and shift the supply
curve to the right, price:
• Price declines with each shift of the
supply curve to the right.
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Parity Pricing
Parity pricing
• Parity pricing describes one criteria
used to determine the level at which a
price floor should be set.
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Parity Pricing
Parity pricing
• It asks for equality between the prices
that farmers have to pay for the goods
they buy, and the prices they get for the
goods they sell.
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Parity Pricing
Parity pricing
• Parity pricing was adopted by the
government in 1933 when Congress
passed the Agricultural Adjustment Act.
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EXHIBIT 10
SHOES AND
CORN: SHIFTS
IN DEMAND
AND SUPPLY:
1914–2000
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Exhibit 10: Shoes and Corn: Shifts in
Demand and Supply: 1914-2000
In Exhibit 10, the market for
shoes changes from 1914 to 1964:
• While the supply curve for shoes
remained unchanged, the demand curve
for shoes shifted to the right.
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Exhibit 10: Shoes and Corn: Shifts in
Demand and Supply: 1914-64
In Exhibit 10, the market for
shoes changes from 1914 to 1964:
• The shift in demand raised the
equilibrium price for shoes from $2 to $4.
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Exhibit 10: Shoes and Corn: Shifts in
Demand and Supply: 1914-2000
The market for corn changed in
the same time period:
• The demand curve for corn remained
unchanged, while breakthroughs in
technology and chemicals shifted the
supply curve for corn to the right.
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Exhibit 10: Shoes and Corn: Shifts in
Demand and Supply: 1914-2000
The market for corn changed in
the same time period:
• The equilibrium price of corn declined
from $2 in 1914 to $1 in 1964.
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Exhibit 10: Shoes and Corn: Shifts in
Demand and Supply: 1914-2000
Parity pricing affects the quantity
of corn demanded and supplied:
• Parity pricing, setting a price floor of $4
for corn, restores the exchange parity
between corn and shoes.
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Exhibit 10: Shoes and Corn: Shifts in
Demand and Supply: 1914-2000
Parity pricing affects the quantity
of corn demanded and supplied:
• It also creates an excess supply of 50
million bushels of corn.
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Parity Price Ratio
Parity price ratio
• The relationship between prices received
by farmers and prices paid by farmers.
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EXHIBIT 11 PARITY PRICE RATIOS OF PRICES RECEIVED
AND PAID BY FARMERS: 1910–2000
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Exhibit 11: Parity Price Ratios of Prices
Received by Farmers and Paid by
Farmers: 1910-2000
Changes in the parity price ratio
since 1910:
• Except for the period between 1910 and
1920 and during the 1940s, the parity price
ratio has been on the decline.
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Commodity Credit Corporation
The Commodity Credit
Corporation (CCC)
• The CCC is the federal agency
established by the Agricultural
Adjustment Act of 1933 to absorb the
excess farm supply created by parity
pricing.
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Commodity Credit Corporation’s
Loans: Public Law 480
In 1954 Congress enacted the
Food for Peace law:
• Designed to help U.S. farmers, its impact
on Third World countries has been the
difference between survival
and national disaster.
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Target Price
Target price
• A minimum price level for specific farm
goods that the government sets and
guarantees.
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Target Price
Target price
• A deficiency payment is a government
payment to farmers based on the
difference between the target price set by
government and the market price.
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Target Price
Target price
• Congress moved from parity pricing to
setting target prices in 1973 with the
passage of the Agricultural and
Consumer Protection Act.
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EXHIBIT 12 COMPARING THE OUTCOMES OF PARITY
AND TARGET PRICING
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Exhibit 12: Comparing the Outcomes
of Parity and Target Pricing
Government expenditures on corn differ
between the parity system and the target
system:
With parity pricing, the government absorbs
the excess corn supply:
• Of 50 million bushels.
• At a subsidy price of $4 per bushel.
• A total subsidy of $200 million.
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Exhibit 13: Comparing the Outcomes
of Parity and Target Pricing
Government expenditures on corn differ between
the parity system and the target system:
With target pricing:
• Government guarantees farmers $4 per bushel.
• Consumers purchase all 135 million bushels
at the equilibrium price of $1 per bushel.
• Government must make up the difference of
$3 per bushel for a total of $405 million.
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Exhibit 13: Comparing the Outcomes
of Parity and Target Pricing
The crop restriction in target
pricing affects the deficiency
payment:
• The crop restriction limits the number of
acres a farmer can plant.
• Reducing the quantity of corn supplied
from 135 million to 100 million
bushels.
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Exhibit 13: Comparing the Outcomes
of Parity and Target Pricing
The crop restriction in target
pricing affects the deficiency
payment:
• Consumers pay the new equilibrium
price of $3 per bushel.
• Government pays the $1 per bushel
deficiency payment.
• The total payment is $100 million.
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