Unit 2 – Demand and Supply

Price Controls &Consumer Surplus

Quiz on all of this is Friday:What do you need to do?

- Make sure you have read Ch. 3 and p. 85 - 90 in their entirety.

- As you read, write down any questions that you have. Anything that doesn’t make sense, you have to try to figure out, or you have to ask about in class the next day.

- Do the assigned study questions. We don’t usually review them. Sometimes I don’t talk about the exact same things, but I am assuming you understand them and the concepts behind them.

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Price Ceilings: The government sets a maximum price. It is only an “effective” price ceiling if it is set below equilibrium price.

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Effective price ceilings appear at the bottom of the graph (below equilibrium price).

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Price Ceilings: What is the immediate effect of a price ceiling?

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Shortages

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Effective price ceilings appear at the bottom of the graph (below equilibrium price).

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Price Ceilings: What are the long term effects of a price ceiling?

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Shortages

Rationing Problem

Black Markets

Suppliers allocate too few resources to the product.

Market doesn’t achieve allocative efficiency.

Example: rent control in NYC.

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Price Floors: The government sets a minimum price. It is only an “effective” price floor if it is set above equilibrium price.

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Effective price floors appear at the top of the graph (above equilibrium price).

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Price Floors: What is the immediate effect of a price floor?

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Surpluses

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Pf Effective price floors appear at the top of the graph (above equilibrium price).

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Price Floors: What are the long term effects of a price floor?

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Surpluses

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Govt. needs to do something with the surplus.

Taxpayers end up paying for it.

Suppliers allocate too many resources to the product.

Market doesn’t achieve allocative efficiency.

Example: wheat prices after World War I.

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Quantity Controls: The government sets a maximum quantity or quota. An effective quantity control must be less than equilibrium quantity.

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Effective quantity controls appear at the left of the graph (below equilibrium quantity).

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Consumer Surplus: the difference between the amount consumers were willing to pay for a product and the amount they had to pay (the price).

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Consumer Surplus To find consumer surplus on a graph, look for the area above the price, and below the demand curve.

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Producer Surplus: the difference between the amount producers were willing to sell the product for and the amount the actually got (the price).

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Producer Surplus To find producer surplus on a graph, look for the area below the price, and above the supply curve.

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Total Surplus: Is the sum of consumer surplus and producer surplus.

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Consumer Surplus+

Producer Surplus= Total Surplus

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Notice: Price Ceilings take away from total surplus.(mostly from producer surplus, which makes sense).

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This area of lost surplus is called deadweight loss. It represents mutually beneficial transactions that buyers and sellers would like to have made, but could not.

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Notice: Price floors take away from total surplus.

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This area of lost surplus is called deadweight loss. It represents transactions that buyers would not voluntarily make, but happened anyway. Total surplus is now the light and dark triangles minus the checkered one.

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Notice: Quotas also take a away from total surplus and cause deadweight loss.

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