Transcript With target pricing

Chapter 6
Price Ceilings and Price
Floors
© 2002 South-Western
Economic Principles
•
•
•
•
•
•
Government Intervention in Markets
Price Ceilings
Price Floors
Parity Pricing
Target Prices
Crop Limitation Programs
2
EXHIBIT 1 PRODUCTION POSSIBILITIES CURVE FOR
CIVILIAN AND DEFENSE GOODS
3
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.
4
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.
5
EXHIBIT 2 THE FISH MARKET BEFORE AND AFTER
THE DRAFT
6
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.
7
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.
8
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.
9
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.
10
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.
11
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.
12
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.
13
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. e rich.
14
Price Ceiling
Price Ceiling:
• A maximum price set by government
below the market-generated equilibrium
price.
15
EXHIBIT 3 SETTING A $4 PRICE CEILING IN THE
FISH MARKET
16
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.
17
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.
18
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,
there is a shortage -- an unsatisfied
excess demand -- of 6,000 fish.
19
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.
20
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.
21
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.
22
Price Ceiling and Housing
Rent control is a government-set
price ceiling on rent.
23
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.
24
Price Floors
Price floor:
• A minimum price set by government
above the market-generated equilibrium
price.
25
EXHIBIT 4 EFFECT OF NEW TECHNOLOGY ON
THE FISH MARKET
26
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.
27
Exhibit 4: Effect of New
Technology on the Fish Market
After adopting the new technology,
total revenue for the fisherman:
• Total revenue decreases.
28
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.
29
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.
30
EXHIBIT 5 SETTING A $4 PRICE FLOOR IN THE
FISH MARKET
31
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.
32
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.
33
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.
34
Exhibit 6: Growth of US Agricultural
Productivity Throughout US History
Agricultural productivity has
increased in the US because:
• Changes in the dominant energy source
technology used on farms.
35
Exhibit 6: Growth of US Agricultural
Productivity Throughout US History
Agricultural productivity has
increased in the US because:
• Advances in modern chemistry to produce
fertilizers, insecticides, crop ripeners and
food preservatives.
36
EXHIBIT 7 NUMBER AND SIZE OF U.S. FARMS: 1945–95
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.
37
Exhibit 7: Number and Size of US
Farms: 1945-1995
Since 1945, the average size of
US farms:
• The average size of US farms has
steadily increased, from 195 acres in
1945 to 496 acres in 1995.
38
Exhibit 7: Number and Size of US
Farms: 1945-1995
The number of farms in the US:
• The number of farms has declined
from about 6 million in 1945 to
about 2 million by 1995.
39
EXHIBIT 8 INDEXES OF TOTAL FARM OUTPUT: 1940–96
(1982 = 100)
Source: Historical Statistics of the United States: Colonial Times to 1970: Part 1, Bicentennial Edition, Bureau of the Census, U.S. Department of
Commerce, Series K, Washington, D.C., pp. 414–29, 498–99; Economic Report of the President, 2000, Washington, D.C., p. 416.
40
Exhibit 8: Indexes of Total Farm
Output: 1940-93 (1982 = 100)
Total farm output in the US
between 1940 and 1993 almost:
• Fell by one-half.
• Doubled.
• Tripled.
41
Exhibit 8: Indexes of Total Farm
Output: 1940-93 (1982 = 100)
Total farm output in the US
between 1940 and 1993 almost:
•Fell by one-half.
•Doubled.
• Tripled.
42
EXHIBIT 9 EFFECT OF NEW TECHNOLOGY IN FARMING
43
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.
44
Parity Pricing
Parity Pricing:
• Parity pricing describes one criteria
used to determine the level at which a
price floor should be set.
45
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.
46
Parity Pricing
Parity Pricing:
• Parity pricing was adopted by
the government in 1933 when
Congress passed the Agricultural
Adjustment Act.
47
EXHIBIT 10
SHOES AND
CORN: SHIFTS
IN DEMAND
AND SUPPLY:
1914–64
48
Exhibit 10: Shoes and Corn: Shifts in
Demand and Supply: 1914-64
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.
49
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.
50
Exhibit 10: Shoes and Corn: Shifts in
Demand and Supply: 1914-64
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.
51
Exhibit 10: Shoes and Corn: Shifts in
Demand and Supply: 1914-64
The market for corn changed in
the same time period:
• The equilibrium price of corn declined
from $2 in 1914 to $1 in 1964.
52
Exhibit 10: Shoes and Corn: Shifts in
Demand and Supply: 1914-64
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.
53
Exhibit 10: Shoes and Corn: Shifts in
Demand and Supply: 1914-64
Parity pricing affects the quantity
of corn demanded and supplied:
• It also creates an excess supply of 50
million bushels of corn.
54
Parity Price Ratio
Parity Price Ratio:
• The relationship between prices
received by farmers and prices paid
by farmers.
55
EXHIBIT 11 PARITY PRICE RATIOS OF PRICES RECEIVED
AND PAID BY FARMERS: 1910–96
56
Exhibit 11: Parity Price Ratios of
Prices Received by Farmers and Paid
by Farmers: 1910-90
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.
57
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.
58
Commodity Credit Corporation’s
Loans: 1940-95
Since 1940, the dollar value
of loans changed:
• Loans by the CCC have increased
substantially, from $308 million in 1940
to over $6 billion in 1995.
59
Target Price
Target Price:
• A minimum price level for specific
farm goods that the government sets and
guarantees.
60
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.
61
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.
62
EXHIBIT 12 COMPARING THE OUTCOMES OF PARITY
AND TARGET PRICING
63
Exhibit 13: 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.
64
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
65
$3 per bushel for a total of $405 million.
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.
66
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.
67