A-Level Economics Notes on Price Ceilings and Price Floors

Definitions

1. Price Floor: The minimum price set by the government or a group for a product, good, commodity, or service.
2. Price Ceiling: The maximum price set by the government or a group for a product, good, commodity, or service.
3. Equilibrium Price: The price at which supply equals demand.
4. Quantity Supplied: The amount of a good that producers are willing to sell at a given price.
5. Quantity Demanded: The amount of a good that consumers are willing to buy at a given price.
6. Supply Curve: A graph showing the relationship between the price of a good and the quantity supplied.
7. Demand Curve: A graph showing the relationship between the price of a good and the quantity demanded.
8. Deadweight Loss: The loss of economic efficiency when the equilibrium is not achieved.
9. Government Intervention: Actions taken by the government to affect market outcomes.
10. Market Failure: A situation where the market does not allocate resources efficiently.
11. Commodity: A basic good that is interchangeable with other goods of the same type.
12. Price Control: A government-imposed limit on how low or high a price can be charged for a product, good, commodity, or service.

Diagrams

Figure 1: Price Ceiling

Figure 2: Price Floor

Price Ceilings

A price ceiling is a government-imposed limit on the maximum price that can be charged for a product or service.

1. Objective: The main goal is to make essential goods and services more affordable for consumers. This is often applied to necessities like food, gasoline, and housing.
2. Real-World Example: Rent control in cities like New York aims to make housing affordable for residents. However, it can lead to a shortage of quality housing.
3. Consequences:
   • Shortages: When the price is set below the market equilibrium, demand often exceeds supply.
   • Black Markets: These can emerge where goods are sold at higher, unregulated prices.
   • Quality Reduction: To maintain profitability, producers might reduce the quality of the goods.
4. Graphical Representation: In a supply-demand graph, a price ceiling is represented as a horizontal line below the equilibrium price.

Excess Demand

Excess demand occurs when the quantity demanded of a good or service exceeds the quantity supplied at a specific price level.

1. Causes:
   • Low Prices: Prices below the equilibrium level can lead to excess demand.
   • Increased Consumer Income: More disposable income can boost demand.
   • Advertising: Effective marketing can spike interest and demand.
2. Consequences:
   • Price Increase: Sellers may raise prices to reach a new equilibrium.
   • Shortages: Lack of availability of the product.
   • Black Markets: May emerge for high-demand goods.
3. Graphical Representation: In a supply-demand graph, excess demand is represented by the gap between the demand curve and the supply curve to the right of the equilibrium point.
4. Real-World Example: During holiday seasons, popular toys often experience excess demand, leading to higher prices and potential shortages.

Price Floors

A price floor is a minimum price set by the government for a particular good or service. This means sellers cannot charge less than this established price.

1. Objective: The primary goal is to ensure that producers receive a minimum income for their products or services. This is often applied to agricultural products and labor markets.
2. Real-World Example: Minimum wage laws are a form of price floor. They aim to provide workers with a livable income but can sometimes lead to unemployment.
3. Consequences:
   • Surpluses: When the price is set above the market equilibrium, supply often exceeds demand.
   • Unemployment: In the context of minimum wage, employers might hire fewer workers.
   • Inefficient Allocation: Resources may not be used optimally, leading to waste.
4. Graphical Representation: In a supply-demand graph, a price floor is represented as a horizontal line above the equilibrium price.

Excess Supply

Excess supply occurs when the quantity of a good or service supplied exceeds the quantity demanded at a given price level.

1. Causes:
   • High Prices: Prices above the equilibrium level can lead to excess supply.
   • Overproduction: Manufacturers may produce more than the market demands.
   • Decreased Consumer Interest: A decline in consumer interest can result in unsold goods.
2. Consequences:
   • Price Reduction: To clear the excess, sellers may lower prices.
   • Inventory Costs: Holding onto unsold goods can incur storage costs.
   • Waste: Perishable goods may spoil, leading to waste.
3. Graphical Representation: In a supply-demand graph, excess supply is represented by the gap between the supply curve and the demand curve to the left of the equilibrium point.
4. Real-World Example: After a holiday season, stores often have excess supply of seasonal items, leading to clearance sales.