ECONOMICS

Chapter 5, Section 3Managing Prices

A. Limitations in the Market

• There are limits to the price system• These limits include positive and

negative externalities, the cost of public goods, and instability of the market

• Government sometimes intervenes to keep the market functioning smoothly and avoid instability

• Government intervenes by setting prices and rationing

A. Setting Prices

• Government sets prices to protect consumers and producers from dramatic price swings

• Government uses price ceilings and price floors to set prices

B. Price Ceilings and Price Floors

PRICE CEILINGS• A maximum price set

by government• Below equilibrium• A shortage is created• Ex.-Rent Control

PRICE FLOORS• A minimum price set

by government• Above equilibrium• A surplus is created• Ex.-Minimum Wage

PRICE CEILINGS• 1. A maximum

price set by government

• 2. Below equilibrium

• 3. To make goods/services affordable

• 4. Ex.-Rent Control

S

P

Price CeilingD

Q

B. Price Ceilings and Price Floors

PRICE CEILINGS• A maximum price set

by government• Below equilibrium• A shortage is created• Ex.-Rent Control

PRICE FLOORS• A minimum price set

by government• Above equilibrium• A surplus is created• Ex.-Minimum Wage

SPrice Floor

P

DQ

PRICE FLOORS• 1. A minimum

price set by government

• 2. Above equilibrium

• 3. To prevent prices from falling too low

• 4. Ex.-Minimum Wage

C.

• 1. What problems can be caused through interference in the market?

• An imbalance/equilibrium not being met; shortages and surpluses

C.

• 2. How do price ceilings create shortages?

• Lower prices create higher demand

C.

• 3. What problems exist for landlords when government enacts rent controls?

• Lower prices mean lower profits• Landlords may not build more

rentals or make repairs

C.

• 4. How do price floors create surpluses?

• Higher prices create lower demand

C.

• 5. What benefits exist for farmers when government enacts price floors?

• Farmers can continue to produce their goods because they know the price floor guarantees them a minimum income

C.

• 6. Define ration.• When government tries to control

the supply of a good or service by allowing people to have only a limited amount of it. Government implements a system to ration.

C.

• 7. Why does government ration goods and services?

• Usually because there is a shortage of the good or service

C.

• 8. Provide an example of rationing.• During World War II, the

government rationed coffee, meat, etc.

C.

• 9. Discuss the consequences of rationing:

• A. Unfairness-The price system treats everyone equally, but rationing does not. Rationing may favor one person or group over another.

C.

• 9. Discuss the consequences of rationing:

• B. Cost-Government must print rationing coupons and hire employees to keep track of them. Then the system must be implemented and monitored.

C.

• 9. Discuss the consequences of rationing:

• C. Black Markets-Rationing may encourage consumers and producers to exchange goods illegally at prices higher than the established price. Rationing encourages black markets because it does not satisfy consumers’ demand.

D1.

• It is 1942 and World War II has erupted. In the United States, many products, such as meat and gasoline, are in short supply. What steps might the U.S. government take to allocate scarce goods?

D2.

• The high-tech industry is booming in Los Angeles county. Hundreds of people earning high wages are moving into the city each month. Rapidly rising apartment prices are the result. Many poorer residents can no longer afford to live in the city and are having to move to less desirable areas. What should the local government do?

D3.

• Increasing numbers of people are moving to a new settlement on Mars in hopes of economic gain. Unfortunately, jobs are scarce, and competition is stiff. Wages have dropped to all-time lows as people, desperate for work, accept any pay offered. What should the government of Mars do?