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Price elasticity of demand with effect of price ceiling of rice prices

Principles of Economics Search for: The books on open. All book content will remain the same, but the appearance of the books will change to a new, upgraded design. Price Floors and Price Ceilings Next Learning Objectives Use the model of demand and supply to explain what happens when the government imposes price floors or price ceilings.

Discuss the reasons why governments sometimes choose to control prices and the consequences of price control policies. So far in this chapter and in the previous chapter, we have learned that markets tend to move toward their equilibrium prices and quantities. Surpluses and shortages of goods are short-lived as prices adjust to equate quantity demanded with quantity supplied.

In some markets, however, governments have been called on by groups of citizens to intervene to keep prices of certain items higher or lower than what would result from the market finding its own equilibrium price. In this section we will examine agricultural markets and apartment rental markets—two markets that have often been subject to price controls.

Through these examples, we will identify the effects of controlling prices. In each case, we will look at reasons why governments have chosen to control prices in these markets and the consequences of these policies. Agricultural Price Floors Governments often seek to assist farmers by setting price floors in agricultural markets.

4.2 Government Intervention in Market Prices: Price Floors and Price Ceilings

A minimum allowable price set above the equilibrium price is a price floor. With a price floor, the government forbids a price below the minimum. Notice that, if the price floor were for whatever reason set below the equilibrium price, it would be irrelevant to the determination of the price in the market since nothing would prohibit the price from rising to equilibrium. A price floor that is set above the equilibrium price creates a surplus. Suppose the government sets the price of wheat at PF.

Notice that PF is above the equilibrium price of PE. At PF, we read over to the demand curve to find that the quantity of wheat that buyers will be willing and able to purchase is W1 bushels. Reading over to the supply curve, we find that sellers will offer W2 bushels of wheat at the price floor of PF.

The surplus persists because the government does not allow the price to fall. Why have many governments around the world set price floors in agricultural markets? Farming has changed dramatically over the past two centuries.

Technological improvements in the form of new equipment, fertilizers, pesticides, and new varieties of crops have led to dramatic increases in crop output per acre.

Worldwide production capacity has expanded markedly. As we have learned, technological improvements cause the supply curve to shift to the right, reducing the price of food.

Agricultural Price Floors

While such price reductions have been celebrated in computer markets, farmers have successfully lobbied for government programs aimed at keeping their prices from falling. While the supply curve for agricultural goods has shifted to the right, the demand has increased with rising population and with rising income.

But as incomes rise, people spend a smaller and smaller fraction of their incomes on food. While the demand for food has increased, that increase has not been nearly as great as the increase in supply. As a result, equilibrium quantity has risen dramatically, from Q1 to Q2, and equilibrium price has fallen, from P1 to P2. On top of this long-term historical trend in agriculture, agricultural prices are subject to wide swings over shorter periods. Droughts or freezes can sharply reduce supplies of particular crops, causing sudden increases in prices.

Demand for agricultural goods of one country can suddenly dry up if the government of another country imposes trade restrictions against its products, and prices can fall. Such dramatic shifts in prices and quantities make incomes of farmers unstable. The Great Depression of the 1930s led to a major federal role in agriculture. The Depression affected the entire economy, but it hit farmers particularly hard. Prices received by farmers plunged nearly two-thirds from 1930 to 1933.

  • At this price, demand is Q3 and supply of rice is Q1;
  • As a variation on this program, the government can require farmers who want to participate in the price support program to reduce acreage in order to limit the size of the surpluses.

Many farmers had a tough time keeping up mortgage payments. By 1932, more than half of all farm loans were in default. Farm legislation passed during the Great Depression has been modified many times, but the federal government has continued its direct involvement in agricultural markets. This has meant a variety of government programs that guarantee a minimum price for some types of agricultural products.

These programs have been accompanied by government purchases of any surplus, by requirements to restrict acreage in order to limit those surpluses, by crop or production restrictions, and the like.

To see how such policies work, look back at Figure 4. At PF, W2 bushels of wheat will be supplied. With that much wheat on the market, there is market pressure on the price of wheat to fall. To prevent price from falling, the government buys the surplus of W2 — W1 bushels of wheat, so that only W1 bushels are actually available to private consumers for purchase on the market. The government can store the surpluses or find special uses for them.

For example, surpluses generated in the United States have been shipped to developing countries as grants-in-aid or distributed to local school lunch programs.

As a variation on this program, the government can require farmers who want to participate in the price support program to reduce acreage in order to limit the size of the surpluses. For farmers to receive these payments, they had to agree to remove acres from production and to comply with certain conservation provisions.

These restrictions sought to reduce the size of the surplus generated by the target price, which acted as a kind of price floor. What are the effects of such farm support programs? The intention is to boost and stabilize farm incomes. But, with price floors, consumers pay more for food than they would otherwise, and governments spend heavily to finance the programs.

With the target price approach, consumers pay less, but government financing of the program continues. However, since farm aid has generally been allotted on the basis of how much farms produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.

If the goal is to eliminate poverty among farmers, farm aid could be redesigned to supplement the incomes of small or poor farmers rather than to undermine the functioning of agricultural markets. In 1996, the U. The thrust of the new legislation was to do away with the various programs of price support for most crops and hence provide incentives for farmers to respond to market price signals. To protect farmers through a transition period, the act provided for continued payments that were scheduled to decline over a seven-year period.

However, with prices for many crops falling in 1998, the U. Congress passed an emergency aid package that increased payments to farmers.

It did, however, for the first time limit payments to the wealthiest farmers. Rental Price Ceilings The purpose of rent control is to make rental units cheaper for tenants than they would otherwise be. Unlike agricultural price controls, rent control in the United States has been largely a local phenomenon, although there were national rent controls in effect during World War II. Many other cities in the United States adopted some form of rent control in the 1970s. Rent controls have been pervasive in Europe since World War I, and many large cities in poorer countries have also adopted rent controls.

Rent controls in different cities differ in terms of their flexibility. Some cities allow rent increases for specified reasons, such as to make improvements in apartments or to allow price elasticity of demand with effect of price ceiling of rice prices to keep pace with price increases elsewhere in the economy.

Often, rental housing constructed after the imposition of the rent control ordinances is exempted. Apartments that are vacated may also be decontrolled. For simplicity, the model presented here assumes that apartment rents are controlled at a price that does not change. Notice that the demand and supply curves are drawn to look like all the other demand and supply curves you have encountered so far in this text: The demand curve shows that a higher price rent reduces the quantity of apartments demanded.

For example, with higher rents, more young people will choose to live at home with their parents. With lower rents, more will choose to live in apartments. Higher rents may encourage more apartment sharing; lower rents would induce more people to live alone. The supply curve is drawn to show that as rent increases, property owners will be encouraged to offer more apartments to rent. Even though an aerial photograph of a city would show apartments to be fixed at a point in time, owners of those properties will decide how many to rent depending on the amount of rent they anticipate.

1.3 Government intervention – Maximum Price

Higher rents may also induce some homeowners to rent out apartment space. Rent control is an example of a price ceilinga maximum allowable price. With a price ceiling, the government forbids a price above the maximum. A price ceiling that is set below the equilibrium price creates a shortage that will persist. Suppose the government sets the price of an apartment at PC in Figure 4. Notice that PC is below the equilibrium price of PE. At PC, we read over to the supply curve to find that sellers are willing to offer A1 apartments.

Reading over to the demand curve, we find that consumers would like to rent A2 apartments at the price ceiling of PC.

  • Rent control is an example of a price ceiling , a maximum allowable price;
  • Sometimes the government will allow the consumers that were already consuming to continue consuming;
  • If a price ceiling is set, then there must be a way to assign who gets the low supply of the product;
  • Rent controls in different cities differ in terms of their flexibility;
  • One way to distribute a product for which there is a shortage is to draw names out of a hat.

Because PC is below the equilibrium price, there is a shortage of apartments equal to A2 — A1. Notice that if the price ceiling were set above the equilibrium price it would have no effect on the market since the law would not prohibit the price from settling at an equilibrium price that is lower than the price ceiling.

If rent control creates a shortage of apartments, why do some citizens nonetheless clamor for rent control and why do governments often give in to the demands? The reason generally given for rent control is to keep apartments affordable for low- and middle-income tenants. But the reduced quantity of apartments supplied must be rationed in some way, since, at the price ceiling, the quantity demanded would exceed the quantity supplied.

  1. As with price floors, interfering with the market mechanism may solve one problem, but it creates many others at the same time.
  2. Key Takeaways Price floors create surpluses by fixing the price above the equilibrium price. Did not other factors, such as weather and rising food demand worldwide, contribute to higher grain prices?
  3. As a variation on this program, the government can require farmers who want to participate in the price support program to reduce acreage in order to limit the size of the surpluses. Having said that, workers could become more productive and other benefits associated with better nutrition arise.
  4. Corn-based ethanol does little to reduce U. While the supply curve for agricultural goods has shifted to the right, the demand has increased with rising population and with rising income.

Current occupants may be reluctant to leave their dwellings because finding other apartments will be difficult. In fact, reading up to the demand curve in Figure 4.

  • But as incomes rise, people spend a smaller and smaller fraction of their incomes on food;
  • This would be hard to do since after the price ceiling there will be many more people claiming they have consumed in the past;
  • By 1932, more than half of all farm loans were in default.

In the end, rent controls and other price ceilings often end up hurting some of the people they are intended to help. Many people will have trouble finding apartments to rent. Ironically, some of those who do find apartments may actually end up paying more than they would have paid in the absence of rent control.

And many of the people that the rent controls do help primarily current occupants, regardless of their income, and those lucky enough to find apartments are not those they are intended to help the poor.