Price Ceilings, Price Floors, and Black Markets - Online Tutor, Practice Problems & Exam Prep

Price ceilings set a legal maximum price, often leading to shortages when below equilibrium, as seen in rent control. Conversely, price floors establish a minimum price, causing surpluses when above equilibrium, exemplified by minimum wage laws. Both regulations can create market inefficiencies, prompting black markets where trades occur outside legal limits. Understanding these concepts is crucial for grasping market dynamics, including demand and supply interactions, equilibrium price, and the implications of government intervention in economics.

Price Ceilings

Now let's discuss what happens when the government steps in and regulates prices of a product. The first one we're going to talk about is a price ceiling. If you think about it, it's when the government sets a legal maximum, right? The maximum price that can be charged. So that kind of makes sense, right? A ceiling you can't go above. Alright, let's go to the graph and talk about how a price ceiling can be effective versus ineffective. The government steps into a market and says the prices are out of control here; we need to set a maximum price that can be charged.

Let's first discuss this ineffective price ceiling using our standard graph with Price and Quantity axes, demand and supply, and we've got this equilibrium point right where we're at P_star and Q_star. A common example is the idea of rent control. Price ceilings usually happen in these rental markets, so let's use that as our example. In a market where the equilibrium price for rent is $1,000 a month, the government might say, "Prices are getting out of control, you can't charge more than $1200 a month." They set this higher price, labeling it P_high. Since everyone's already renting apartments and trading this good at $1000, when the government limits the price to no more than $1200, it has no effect on the market. The market will keep trading at $1000.

Now let's consider an effective price ceiling. We have the same Price and Quantity axes and our demand and supply curves. The equilibrium price is still $1000 a month for rent. This time, the government steps in and says, "You can't charge more than $800 a month." This is going to have an effect. The market wants to trade at $1000, but now the highest allowable charge is $800. At this lower price, the quantities supplied and demanded aren't equal anymore. The first dot represents our quantity supplied, and the dot on the demand curve represents our quantity demanded. At this lower price, people don't want to rent their apartments anymore, creating a shortage. The supply is much less than the demand. This scenario confirms that for a price ceiling to be effective, it must be set below equilibrium and will cause a shortage in the market.

Here's a trick to remember the impact of price ceilings. Imagine a price ceiling on the graph creating a little house, with the ceiling being our low price. You can only make this house when the price is below equilibrium. On the other side, it wouldn't work; it would create an upside-down shape. This helps remember how price ceilings affect the market. Soon, we'll learn about price floors and how they differ. Before we finish, let's recap common topics like rent control, which we've discussed, and rationing coupons. Rationing coupons come into play when there are shortages due to a price ceiling; the government issues coupons that allow purchasing a unit of the good at the government price but only in limited quantities. These are important considerations when discussing price ceilings. So, let's try an example related to price ceilings in the next video.

Price Ceilings

Alright, so we've got an example here. Consider the following graph. A price ceiling of $20 would cause a surplus of 500 units, a shortage of 500 units, surplus of 1,000, shortage of 1,000 or no effect, alright. So we have to remember with price ceilings, they set a price too low if they're effective, right? And when the price is too low, the demand is going to outweigh the supply, so we're going to be in a situation where there's a shortage if there's this price ceiling if it's effective, right? So off the bat we can cancel these that say surplus. We know it's not going to be any of those answers, but even if we can't do that, remember that specific knowledge on the test, we do have the graph and let's go ahead and look at the graph and see if we can figure out, the surplus or the shortage or what effect we have here. So the first thing we want to check is is this an effective price ceiling? And my trick remember is the house trick. So notice that at this price of $20 we do get a house, right? We get the house, so we can say that it is an effective price ceiling because we got the house there, so we know that it's going to affect the market and it's going to do something here. So let's see what happens here. The government says you can't charge a price more than 20 the market wants to trade at 25, so this is going to be effective. So what do we have here? This is going to be the supply curve, right? Because we have our downward demand, double d's, supply is the other one. Right? So what happens here at the price of $20, 500 is going to be our quantity supplied, right? That's where the $20 touches the supply curve and a 1,000 over here that's going to be the quantity demanded, right, that's where the $20 is touching the demand curve. So what do you have? We have a quantity supplied of 500, a quantity demanded of 1,000. There's a shortage, right? People want 1,000, but there's only 500 available. So that difference there between the 500 and 1,000 is the shortage. Right? So the shortage isn't a thousand. There's not a thousand shortage. There's still 500 units available. It's the other 500 that are missing that's the shortage. So the quantity demanded being a thousand minus the quantity supplied of 500. If we subtract those, we're going to get 500 which is the shortage. So we have a shortage of 500 units in this case. Alright? So let's go ahead and go to the next video.

When the government imposes a binding price ceiling, it causes

• A. The supply curve to shift to the right
• B. The demand curve to shift to the right
• C. A shortage of the good
• D. A surplus of the good

A price ceiling will have no impact on a market if it is set

• A. below last year's average price
• B. above the equilibrium price
• C. by knowledgeable government officials
• D. below the equilibrium price

All of the following are problems associated with price ceilings except:

• A. chronic excess demand
• B. an eventual decline in the number of suppliers
• C. the need to use ration coupons to purchase a good
• D. chronic excess supply
• E. landlords failing to maintain rent-controlled properties adequately

Price Floors and Black Markets

So just like the government can set legal maximum prices, they can do the same thing with minimum prices. We talked about price ceilings and how that was a maximum price that can be charged. Well, the price floor, what do you think? It's going to be the opposite here. It's going to be the legally determined minimum price that can be charged, right? So just like before, let's go ahead and go to the graph and let's discuss what makes an effective price floor, and then we'll go back and fill in our little summary there. And just if you think ahead, you can think that this is going to be the opposite of a price ceiling, right? And when we do our example here, we're going to talk about minimum wage. This is a very common topic when you talk about price floors. A minimum price, so the minimum wage that can be paid. Alright, so let's first talk about this ineffective price floor on the left-hand side one. So we've got our common price quantity graph with our demand curve and our supply curve, right, and our equilibrium right here. So let's say that in this market, it's a labor market, right? We're going to have an equilibrium wage here of let's say $10 to keep it easy, and then the government comes in and says hey, you can't pay anybody less than $6, that's not okay. So the minimum wage in this case, the government steps in and says you need to be paying people at least $6. Well, the market's already at 10, right? The demand and the supply at equilibrium is 10, so they're going to keep trading at 10 just like we saw with the price ceiling. This is going to have no effect, right? The minimum price that they put there of $6 an hour, well everyone's already trading at 10, they're just going to keep doing what they're doing. They're already above the minimum, they're not breaking the law, so they're just going to keep doing what they're doing. The price floor has no effect on the market. So let's go ahead, I'm going to get out of the way and let's talk about the effective price floor behind me.

Same thing, our price and quantity axes with our demand and supply curves and now this time we've got the same equilibrium here in the middle. Oops. This is our quantity axis down here. Quantity and price, right, and now the government steps in and people are trading at 10, right? And the government steps in and says, hey, everyone's been going crazy about it. We've got the minimum wage at $15 now. Right? Bernie Sanders is in office and he sets that $15 minimum wage and let's see what happens. So the minimum wage comes into play. Everyone's really happy. Hey, we're going to be making more money, but what is going to happen in this market, right? So remember this is a labor market, so the supply of labor is people who have labor and go to work. So like if you have a job, you supply labor, right? Compared with the demand, which is the companies that hire you. So in this case at this high wage, companies are demanding less labor. Right? They can't afford it. They're going to demand less of it and use other resources instead of labor to create their products like robots or something like that. So we're going to have the quantity demanded over here and at this $15 minimum wage everyone wants a job now. Everyone who is just sitting around is like man, I could use $15 an hour, that sounds good. The quantity supplied of labor is going to be way up here and what are we going to find ourselves with? We're going to find ourselves with way too much labor on the market and not enough jobs, right. So there's not going to be enough jobs to fill this up. There's going to be a surplus of labor, right. There's not enough jobs, there's going to be a surplus of labor, everyone's looking for a job at this $15 an hour rate, but nobody wants to hire, right? So just like before that is going to be our effective price floor and now it's when it's above equilibrium, right? So this effective price floor let's write it up here. For it to be effective, the price floor must be above equilibrium, right? And what did we see? That an effective price floor causes a surplus in the market, right? The supply of labor in this case was much greater than the demand for labor at the price floor. So just like we saw with the price ceiling, righ...

Isn't it always easier to just memorize one thing rather than two things, right? So if you just remember the price ceiling one and just remember that the other one's the opposite, you can leverage that a lot in economics because we deal with opposites quite often. Alright, one more thing I want to discuss in this video is the idea of black markets. Okay, so I'm sure you've heard the term black market before where kind of shady things happen. Black markets happen when the government has stepped in and regulated the price or the quantity of a good and people want to exchange anyway, right? There's this inefficiency that the government's created and the black market is where people try and make up for it behind the law, right? So here are some examples of things that happen in black markets, right. The first one is hiring workers at less than minimum wage, right. Sometimes you see people getting hired under the table and they can pay them less than minimum wage. Stuff like that. Very common one. Just like we saw in our price ceiling example, right, renting apartments above the rent controlled limits, right? So the government had stepped in and said you can't charge more than this rent, but now pe...

Price Floors

Alright. Let's try this example. Consider the following graph. A price floor of $20 would cause a surplus of surplus of 1,000 units, a shortage of 1,000 units or no effect. All right, so the first thing we want to check when we get a price floor or price ceiling problem is whether or not the price floor or price ceiling is going to be effective, right? And I use my trick of that little house to figure out if it's effective or not, right? Because you're on the test and you're like man, is price floor, price ceiling, which one's below equilibrium, which one's above equilibrium? Well, just remember that the ceiling is the one that makes the house with the ceiling price that's effective, right? We've got the house right here and this ceiling of the house is our ceiling price that makes an effective price ceiling, right? So boom, right there I remembered on the test that effective price ceilings are below equilibrium, right? That's what we see in this problem, an equilibrium of 25 and an effective price ceiling below equilibrium. So then now that I've figured out ceilings I know that floors are the opposite, right? And in this question we're talking about price floors, right? So now that I know that an effective price ceiling is below equilibrium from my house trick, I know that an effective price floor is above equilibrium, right? Above and I just figured this out just from the little house trick. So now I can go back to my graph. I'm going to erase all this, right? Well, I can leave the p star and so all of that was just to think was it effective or ineffective? Boom. We know that an effective price floor would be above equilibrium and what do we have here? A price floor of $20 which is below equilibrium, right? So this is an ineffective price floor and just like that we know that the answer is going to be no effect, right? At this price floor the government set a minimum of $20 that could be charged, but it doesn't matter to the market because they were trading at $25 which is above the minimum, right? And that's okay, that's within the law and they're just going to keep doing what they were doing and trading at $25. So the answer here is no effect. Let's go ahead and move on to the next video.

Which of the following statements regarding the expected effects of a price control imposed on a competitive market is false?

• A. A price floor above the competitive equilibrium price will result in a surplus.
• B. A price ceiling above the competitive equilibrium price will result in a surplus.
• C. A price ceiling below the competitive equilibrium price will result in a shortage.
• D. A nonbinding price floor will result in a quantity exchanged that is equal to the equilibrium quantity

Here’s what students ask on this topic:

What is a price ceiling and how does it affect the market?

A price ceiling is a government-imposed limit on how high a price can be charged for a product. It is set below the equilibrium price to be effective. When a price ceiling is implemented, it often leads to a shortage because the quantity demanded exceeds the quantity supplied at the capped price. For example, in rent-controlled markets, landlords may not find it profitable to rent out their properties, leading to fewer available rental units. This creates inefficiencies in the market, as the natural balance of supply and demand is disrupted.

What is a price floor and what are its economic implications?

A price floor is a government-set minimum price that must be paid for a good or service. It is effective when set above the equilibrium price. A common example is the minimum wage. When a price floor is implemented, it can lead to a surplus because the quantity supplied exceeds the quantity demanded at the higher price. For instance, if the minimum wage is set too high, employers may hire fewer workers, leading to unemployment. This creates market inefficiencies as the natural equilibrium of supply and demand is disrupted.

How do black markets emerge in response to price ceilings and price floors?

Black markets emerge when government-imposed price ceilings or price floors create inefficiencies in the market. For example, if a price ceiling on rent is set below the equilibrium price, landlords may illegally charge higher rents under the table. Similarly, if a price floor like a high minimum wage leads to unemployment, workers may accept jobs at lower wages off the books. These black markets allow transactions to occur outside legal limits, attempting to correct the imbalances created by government intervention.

What are some common examples of price ceilings and price floors?

Common examples of price ceilings include rent control, where the government sets a maximum rent that can be charged to prevent housing costs from becoming unaffordable. An example of a price floor is the minimum wage, which sets the lowest legal wage that can be paid to workers. Both of these interventions aim to protect consumers and workers but can lead to unintended consequences like shortages in housing or surpluses in labor, respectively.

What are the conditions for a price ceiling to be effective?

For a price ceiling to be effective, it must be set below the market equilibrium price. This means the legal maximum price is lower than what the market would naturally set. When this happens, the quantity demanded exceeds the quantity supplied, leading to a shortage. For example, if the equilibrium rent for an apartment is $1,000 and the government sets a price ceiling at $800, more people will want to rent at the lower price, but fewer landlords will be willing to rent out their apartments, creating a shortage.