So Why Are There Price Ceilings?

We have seen three common results of price ceilings:

Given these unpleasant consequences of price ceilings, why do governments still sometimes impose them? Why does rent control, in particular, persist in New York?

One answer is that although price ceilings may have adverse effects, they do benefit some people. In practice, New York’s rent-control rules—which are more complex than our simple model—hurt most residents but give a small minority of renters much cheaper housing than they would get in an unregulated market. And those who benefit from the controls are typically better organized and more vocal than those who are harmed by them.

Also, when price ceilings have been in effect for a long time, buyers may not have a realistic idea of what would happen without them. In our previous example, the rental rate in an unregulated market (Figure 5-1) would be only 25% higher than in the regulated market (Figure 5-2): $1,000 instead of $800. But how would renters know that? Indeed, they might have heard about black market transactions at much higher prices—the Lees or some other family paying George $1,200 or more—and would not realize that these black market prices are much higher than the price that would prevail in a fully unregulated market.

A last answer is that government officials often do not understand supply and demand analysis! It is a great mistake to suppose that economic policies in the real world are always sensible or well informed.

!worldview! ECONOMICS in Action: Price Controls in Venezuela: “You Buy What They Have”

Price Controls in Venezuela: “You Buy What They Have”

By all accounts, Venezuela is a rich country—one of the world’s top oil producers in a time of high energy prices. But in late 2013, the chronic lack of basic items—toilet paper, rice, coffee, corn, flour, milk, meat—had hit a nerve. “Empty shelves and no one to explain why a rich country has no food. It’s unacceptable,” said Jesús López, a 90-year-old farmer.

Venezuela’s food shortages offer a lesson in why price ceilings, however well intentioned, are usually never a good idea.
Reuters/Daniel Aguilar/Landov

The origins of Venezuela’s food shortages can be traced to the policies put in place by former Venezuelan president Hugo Chávez and continued by his successor, Nicolás Maduro. Chávez came to power in 1998 on a platform denouncing the country’s economic elite and promising policies that favored the poor and working class, including price controls on basic foodstuffs. These price controls led to shortages that began in 2003 and became severe by 2006. Prices were set so low that farmers reduced production. For example, Venezuela was a coffee exporter until 2009 when it was forced to import large amounts of coffee to make up for a steep fall in production. Venezuela now imports more than 70% of its food.

In addition, generous government programs for the poor and working class led to higher demand. The combination of price controls and higher demand led to sharply rising prices for goods that weren’t subject to price controls or that were bought on the black market. The result was a big increase in the demand for price-controlled goods.

Worse yet, a sharp decline in the value of the Venezuelan currency made foreign imports more expensive. And it increased the incentives for smuggling: when goods are available at the government-mandated price, Venezuelans buy them and then resell across the border in Colombia, where a bottle of milk is worth seven or eight times more. Not surprisingly, fresh milk and butter are rarely seen in Venezuelan markets.

Venezuelans, queuing for hours to purchase goods at state-run stores, often come away empty handed. Or, as one shopper, Katherine Huga, said, “Whatever I can get. You buy what they have.” While items can often be found on the black market at much higher prices, Chávez’s price-control policies have disproportionately hurt the lower- and middle-income consumers he sought to help. One shopper in a low-income area who waited in line for hours said, “It fills me with rage to have to spend the one free day I have wasting my time for a bag of rice. I end up paying more at the resellers. In the end, all these price controls proved useless.”

Quick Review

  • Price controls take the form of either legal maximum prices—price ceilings—or legal minimum prices—price floors.

  • A price ceiling below the equilibrium price benefits successful buyers but causes predictable adverse effects such as persistent shortages, which lead to four types of inefficiencies: deadweight loss, inefficient allocation to consumers, wasted resources, and inefficiently low quality.

  • A deadweight loss is a loss of total surplus that occurs whenever a policy or action reduces the quantity transacted below the efficient market equilibrium level.

  • Price ceilings also lead to black markets, as buyers and sellers attempt to evade the price controls.

5-1

  1. Question 5.1

    On game days, homeowners near Middletown University’s stadium used to rent parking spaces in their driveways to fans at a going rate of $11. A new town ordinance now sets a maximum parking fee of $7. Use the accompanying supply and demand diagram to explain how each of the following corresponds to a price-ceiling concept.

    1. Some homeowners now think it’s not worth the hassle to rent out spaces.

    2. Some fans who used to carpool to the game now drive alone.

    3. Some fans can’t find parking and leave without seeing the game.

    Explain how each of the following adverse effects arises from the price ceiling.

    1. Some fans now arrive several hours early to find parking.

    2. Friends of homeowners near the stadium regularly attend games, even if they aren’t big fans. But some serious fans have given up because of the parking situation.

    3. Some homeowners rent spaces for more than $7 but pretend that the buyers are nonpaying friends or family.

  2. Question 5.2

    True or false? Explain your answer. A price ceiling below the equilibrium price of an otherwise efficient market does the following:

    1. Increases quantity supplied

    2. Makes some people who want to consume the good worse off

    3. Makes all producers worse off

  3. Question 5.3

    Which of the following create deadweight loss? Which do not and are simply a transfer of surplus from one person to another? Explain your answer.

    1. You have been evicted from your rent-controlled apartment after the landlord discovered your pet boa constrictor. The apartment is quickly rented to someone else at the same price. You and the new renter do not necessarily have the same willingness to pay for the apartment.

    2. In a contest, you won a ticket to a jazz concert. But you can’t go to the concert because of an exam, and the terms of the contest do not allow you to sell the ticket or give it to someone else. Would your answer to this question change if you could not sell the ticket but could give it to someone else?

    3. Your school’s dean of students, who is a proponent of a low-fat diet, decrees that ice cream can no longer be served on campus.

    4. Your ice-cream cone falls on the ground and your dog eats it. (Take the liberty of counting your dog as a member of society, and assume that, if he could, your dog would be willing to pay the same amount for the ice-cream cone as you.)

Solutions appear at back of book.