Price Ceilings, Price Floors, and Black Markets - Video Tutorials & Practice Problems

Price Ceilings

now let's discuss what happens when the government steps in and regulates prices of a product. So the first one we're gonna talk about is a price ceiling. And if you think about it, it's when the government steps in and sets a legal maximum, right? The maximum price that can be charged. So that kinda makes sense. Right? A ceiling. You can't go above the ceiling. It's the maximum. All right. So we'll get back to these other bullet points right here. But let's go to the graph and let's talk about how a price ceiling can be effective verse ineffective. Right? So the government's gonna step into a market and say hey the prices are out of control here. We need to set a maximum price that can be charged. So let's first discuss this ineffective price ceiling. And I've got our standard graph here, price and quantity axis demand and supply. And we've got this equilibrium point right here, right? Where we're at P. Star and Q. Star. So really common example when we're talking about um a common topic is this idea of rent control. Um So uh price ceilings usually happen in these rental markets. So let's let's use that as our our example here. So let's say we're in a market and the equilibrium price for rent in that market is $1000 a month. Right? And the government steps in and says hey prices are getting out of control. You can't the maximum price you can charge for rent is 1200 a month. Right? So they come in and they set this higher price here. I'm gonna put P. H. For high price And they say you can't charge less. Excuse me you can't charge more than 1200. Right? That's the maximum price that can be charged. Well guess what in this market everyone's already renting apartments and and trading this good at $1000. Right? So when the government steps in and says you can't charge more than 1200 they're like fine we're already trading at 1000. We're just gonna keep trading at 1000. In this case the price ceiling of 1200 has no effect on the market right? The market's gonna keep doing what it was doing and trading at 1000. So now let's consider that and let's take it to this other graph and let's discuss an effective price ceiling. Right? So we've got the same situation price and quantity let me get out of the way here and our demand and supply curves here. Right so again we've got an equilibrium price right here but this time the government steps in. Right? So um the equilibrium price is still 1000 a month for rent and the government steps in and says hey you can't charge more than 800 a month right? You can't charge more than $800 a month for rent. Now you can see that it is gonna have an effect right? The market does want to trade at 1000. But now the government steps in and says you're not allowed to do that anymore. The most you can charge is 800. So what's gonna happen at this lower price? We've kind of seen what happens when there's a low price before, right? And we're gonna kind of see the same thing going on here. So when the price is too low, notice what the quantities, right? We're not trading at equilibrium. So we, the quantity supplied and quantity demanded aren't equal anymore. So this one right here, this first dot, which ones that that's gonna be our quantity supply? Right? And over here this dot where the where it touches the demand curve, that's our quantity demanded. So what do we have at this lower price? People don't want, people don't want to rent their apartments anymore right there, like, hey, I'm not gonna make as much money, I'm not gonna rent it out, so there's gonna be this shortage, right? The supply is much less than the demand. People are like this little price, I want to rent an apartment, so we end up in this shortage. Right? The quantity supplied is less than the quantity demanded. Alright, so notice what's happened here, we found an effective price ceiling when the price was below the equilibrium. Right? So let's go ahead and go to the top here and it says for a price ceiling to be effective? The price ceiling must be below equilibrium, right? That's what we just discovered a liquid bri um No, no, no, let me try that again, equilibrium, right? And effective price ceilings, what do they do, they cause a shortage in the market? Right. Cool. So one thing I want to show you real quick that it's another one of my silly tricks to remember this, but it still works. Um Because what I see a lot of the times is students um here price ceiling and they instinctively think that this above equilibrium is going to be an effective price ceiling, right? I see the logic, right? It's above equilibrium, it's a ceiling but that's gonna be wrong, you're gonna fail the test if you think that, right? So the way I like to remember this, is that a price ceiling, check this out when we've got a price ceiling on this graph, we make a little house right here, right, with our quantity demanded and everything and we've got a house. And guess what the ceiling is, the ceiling is our price, right? That low price. So you can only make this house if you've got a price below equilibrium. Look on the other side, I can't make that house, it's gonna be some upside down shape, it's not gonna work over there, right? So that's kind of how I like to think about it, it's a good trick to remember price ceiling. Um And we're about to learn about price floors in a bit and that's gonna be kind of how we remember downward demand, double Ds versus supply here. We've got the same thing where we've got um we remember the little house for price ceiling and then price floors are just the other one. Right? So before we end here I want to talk about these common topics. We've been talking about rent control a little bit. Right? So rent control um That's like what we just saw in our example where the government steps in and sets a maximum uh rent that can be charged in a market. And that's a common topic with price ceilings and this other one rationing coupons. So what happens? Right, just like we've seen there's shortages when there's a price ceiling, right? People want a lot of it but there's not a big supply because the price is low. So then what happens is the government steps in and makes rationing coupons. That says all right, if you have a coupon you can buy a unit of the good at the government price, right? So you get that good price but you can only buy so much of it, right? Um There's kind of a rationing system in that sense. So that's kind of things. You'll see when you talk about price ceilings but why don't we go on and try an example related to price ceilings in the next video? Cool let's do that. Now

Price Ceilings

Alright. So we've got an example here, um consider the following graph, a price ceiling of $20 would cause a surplus of 500 units. A shortage of 500 units surplus of 1000 shortage of 1000 or no effect. All right 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 gonna outweigh the supply. So we're gonna 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's a surplus. We know it's not gonna 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 cause we got the house there. So we know that it's going to affect the market and it's 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 gonna 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 2500 is going to be our quantity supplied. Right? That's where the 20 touches the supply curve and 1000 over here. That's gonna 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 1000. There's a shortage. Right? People want 1000 but there's only 500 available. So that difference there between the 500 1000 is the shortage. Right So the shortage isn't 1000 there's not 1000 shortage there's still 500 units available. It's the other 500 that are missing. That's the shortage. So the quantity demanded being 1000 minus the quantity supply 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. All right so let's go on 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. So we talked about price ceilings and how that was a maximum price that can be charged. Well, a price floor, what do you think it's gonna be the opposite here, it's gonna 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. Um 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, um we're gonna 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 that can be charged. All right. So let's first talk about this ineffective price floor on the 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 gonna have an equilibrium wage here of let's say $6. Let's say $10. Keep it easy. And then the government sets comes in and says, hey, you can't um 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 and equilibrium is is 10. So they're gonna 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 their of $6 an hour. Well, everyone's already trading at 10, They're just gonna keep doing what they're doing, they're already above the minimum, they're not breaking the law, so they're just gonna keep doing what they're doing. They're the price floor has no effect on the market. So let's go ahead, I'm gonna get out of the way and let's talk about the effective price floor behind me. So same thing, our price and quantity axis with our demand and supply curves, and now this time we've got the same equilibrium here in the middle, oops, there's our quantity access down here, quantity and price, right? And now the government steps in and people were 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 gonna be making more money, but what is gonna 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? Uh compared with the demand, which is the companies that hire you? So in this case that this high wage companies are demanding less labor, right? They can't afford it, they're gonna demand demand less of it and use other things instead of labor to create their products like robots or something like that. So we're gonna have a quantity demanded over here and that this $15 minimum wage. Everyone wants a job. Now, everyone who was just sitting around like, man, I could use $15 an hour. That sounds good. The quantity supplied of labor is gonna be way up here. And what are we gonna find ourselves with? We're gonna find ourselves with way too much labor on the market and not enough jobs, right? So there's not gonna be enough jobs to fill this up, there's gonna be a surplus of labor, right? There's not enough jobs, there's gonna be a surplus of labor. Everyone's looking for a job at this $15 an hour um 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, it's right 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 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, right, we had our trick for the house. And what did we see over here, the ineffective price floor would have been an effective price ceiling. Right over here, we've got our effective price ceiling. We could have had this have been a price ceiling of $6 and it would have been effective. So if you just noticed that that would be an effective price ceiling, well, the effective price floors, just the other one, right? If you remember price ceiling is the one below equilibrium and that you can remember because of the drawing, then price floor has to be the opposite the one that's above equilibrium. Alright, so it's, I think it's 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 is the opposite. You can leverage that a lot in economics because we deal with opposites quite often. Alright, so, 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 and this is black markets happen when the government has stepped in and regulated the price or the quantity of a good and people want to exchange anyways, right? There's this inefficiency that the governments created and the black market is where people try and make up for it um behind the law, right? So here's some examples of things that that happened in black markets, right? The first one is hiring workers at less than minimum wage, right? Sometimes you see people getting hired like under the table and stuff and they can charge or pay them, you know, less than minimum wage. Um stuff like that. Very common one. Or 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 people are gonna try and charge higher rent anyways in sneaky ways. Like maybe they'll get a check for the government amount, check for the government amount and then cash for like extra rent, right? Cash for extra rent. Let me get out of the way. Um So they'll they'll write a check for the government regulated amount and then charge extra in cash. And another black market is the market for illegal drugs buying and selling illegal drugs in this market, right? The government hasn't set any price regulation, but they set the quantity regulation, right? The quantity in this market is zero. There should be zero of these illegal drugs around. But what happens is people still want the drugs. So then there becomes this black market where the trades happen anyways, um behind the eyes of the law. All right. So, we've got black markets when the government regulates price or quantity because it creates inefficiencies and it blocks trades that want to happen. All right. So that's about it here. Let's go ahead and go to the next video and do some examples. Let's do some practice problems. Alright, let's do that now.

Price Floors

Alright, let's try this example, consider the following graph, a price floor of $20 would cause a surplus of 500 A shortage of 500 A surplus of 1000 units, a shortage of 1000 units or no effect. Alright, so the first thing we want to check when we get a price floor a price ceiling problem is whether or not the price floor price ceiling is going to be affected, 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 ones below equilibrium? Which ones 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 and equilibrium of 25 and an effective price ceiling below equilibrium. So that now that I've figured out ceilings, I can 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 the little house trick. So now I can go back to my graph, I'm gonna 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 gonna 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 that's within the law. And they're just gonna 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