bras and panties, no seriously (Chapter 5 Q&A + HL Exercise Qs)

12/10/2012 § 1 Comment

#35 Select a product and create a market supply and demand diagram.

a) Show the equilibrium price and quantity, and set a binding price ceiling.
b) Calculate the change in consumer expenditure/producer revenue.
c) Identify and calculate the government subsidy expenditure needed to eliminate the shortage.

#36 Select a product and create a market supply and demand diagram.

a) Show the equilibrium price and quantity, and set a binding price floor.
b) Calculate the change in consumer expenditure/producer revenue.
c) Identify and calculate the government expenditure needed to eliminate the surplus.

creds to my pa’s iPhone

#44 What is the effect of price controls on allocative efficiency?

Price controls either eliminate or exceed the allocative efficiency of a good. With price ceilings, the allocative efficiency is eliminated completely because society is not producing enough of the good. The price ceiling set up by the government is what decides the price of the good, not the collaborative price that both the suppliers and consumers have agreed upon [subconsciously through the market]. Because of this, there just aren’t enough goods that are being supplied into the market. With price floors, the allocative efficiency isn’t completely eradicated but is instead exceeded. Allocative efficiency is when (MB = MC) marginal benefits equal marginal costs but the price floor ensures that there will be a surplus in the supply of a certain good, meaning that the market exceeds allocative efficiency, which is when there is just enough supply to satisfy the demand. With a price floor, there’s just too much supply.

#46 Evaluate the effectiveness of rent control.

The idea behind rent control is to reduce the cost of housing for lower-income citizens and families. The intentions behind rent control are good, and they mean to help out individuals with less opportunities than the middle-to-upper-class individuals with a higher income. Rent control can cause a series of slightly unfortunate events to the housing market. Firstly, because the price of a typical house or apartment drops, then, falling the law of supply, the supply will decrease and there will be a smaller number of options in the housing market for people who need to buy or rent a house. This generally takes away a large portion of the market for consumers who either were willing and able to buy the apartment from its original equilibrium price, or who were part of the intended target consumers (for whom the rent control tried to make the price cheaper so that they could rent the apartments). What’s more, unsuccessfulness of the market may force some renters to rent out apartments at a price that isn’t the government’s established maximum price – this is illegal and can start to form a black market (for renting apartments). Finally, due to the lack of supply of apartments, the government might have to step in and fix things before someone explodes and they’ll do so by providing subsidies to make up for the shortage caused by the rent control placed in the market in the first place. Depending on how far the supply has fallen by then, the subsidies will definitely prove to be very costly for the government.

 

PRACTICE QUESTIONS

#3 total: 25 marks

(a) Explain the concepts of maximum and minimum price controls. (10 marks)

In these parts of town, we call maximum price controls price ceilings. Price ceilings are the maximum legally allowable price for a good, set by the government itself. The government’s goal is to keep the price of a good low and their main intention is to make basic goods and services more affordable for poor people with a lower income than middle- to upper-class individuals with a higher income. The ceiling is there to prevent the price from increasing any higher than what the government says.

Minimum price controls are called price floors, which are essentially the opposite of price ceilings. A price floor is a minimum legally allowable price for a good, set by the government itself. When a government believes that a good is important and necessary, then they support that good and make sure the price can’t decrease by putting a floor there (so it literally can’t drop below the “floor,” ha-ha). The higher price causes an increase in production (following the law of supply) but also a drop in quantity demanded (following the law of demand).

(b) Evaluate the idea that government intervention in the form of price ceilings and price floors is well intentioned, but often leads to undesirable side effects. (15 marks)

It’s easy to say that government intervention in the form of price controls can lead to very undesirable side effects. These “side effects” are the consequences of price floors and price ceilings. Even if the government (probably – most likely – maybe) holds good intentions to justify the price controls, there are always so many consequences that follow the intervention. With price ceilings, the decrease in price usually causes shortage – producers cut production because of the lower price. There can also be rationing, which is what consumers will do because of the decrease in supply of the good or service. This is inefficient and makes it very difficult for consumers to receive the good. A price ceiling can also eliminate the allocative efficiency of a market, start up informal (black) markets, and decrease the market size for the good all because of the government’s price drop. With price floors, instead of a shortage, the market will undergo a surplus – the maintained high price will encourage producers to continue supplying goods at higher prices (hey, it’s the law of supply) and the supply of a good will be greater than the demand (which decreased at the higher price). Similarly with price ceilings, a price floor can also start black markets and reduce the market size of the good. Also, a price floor guarantees that the market won’t reach its allocative efficiency where society is producing exactly what it needs; nothing more, nothing less. These countless side effects (or consequences) are the results of the price controls. As the leaders of a nation, governments most definitely have to take into account the possibility that all of these consequences will occur before establishing a price control on a good. Citizens, especially the consumers, are simply too susceptible to being affected negatively by these consequences should the government lose control of their price controls.

See what I did there.

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