Question

Conceptual Questions A. For the questions below, answer either true or false. If you answer true, explain why it is true. If you answer false, give a counter-example. In all three examples you may assume demand slopes downward and supply slopes upward (that is, neither curve is either perfectly vertical or horizontal), and that both curves are smooth (like they are in the rent control questions, not discrete like they were in homework 2). • In the simple model of supply and demand covered in this class, a binding price ceiling will always decrease total surplus In the simple model of supply and demand covered in this class, a binding price ceiling will always decrease producer surplus • In the simple model of supply and demand covered in this class, a binding price ceiling will always decrease consumer surplus B. Rent control (and similar price ceilings) are often proposed as a way to reduce inequality by making housing more affordable for the poor. But given your answers to Questions 1.7, can rent control also increase some forms of inequality? (Hint: think about what excess demand/a shortage implies for people seeking an apartment.) C. In lecture I gave you steps for calculating the deadweight loss of a price ceiling. Suppose instead there were a binding price floor (that is, the price is held above the equilibrium price). Propose a set of steps for calculating the deadweight loss of a binding price floor. (Hint: draw a diagram with a binding price floor, identify the deadweight loss triangle, and think about how the steps given in lecture must be adjusted to calculate the base and height of that triangle.)

Answer 1

A) The following case could be shown by way of graphs for market before and after the binding price ceiling

Price Price 600 ke 500 SOD 2 400 F cs 400 - 300 300 + DWL IPS 200 200 - - P.C lod 100 200 300 400 Soo boduantity 0 100 200 300 400 500 600 Quantity

1) The total surplus would always reduce, given the binding price ceiling because there would also be deadweight loss.

Hence the statement is true.

2) The producer surplus as shown in the diagram above, would also reduce, given that the price ceiling would mean that less producers would be willing to sell at a lower price. So the statement is also true.

3) The consumer surplus would increase in some parts and reduce in others. This is because those who are benefitted from the low price ceiling would have a higher consumer surplus, while it would not exist when the number of consumers who are benefitting from it has reduced, still the consumer surplus has risen.

In numerical terms as well, without the price ceiling, the consumer surplus was

CS= 1/2*b*h=1/2*(600-300)*300= 45000

CS1 (After price ceiling)= Area of trapezium=1/2*sum of parallel sides*area between them=

= 1/2*(200)*(400+200)= 1/2*200*600= 60000

So the statement is false as the consumer surplus has increased after the price ceiling

B) Price ceiling is binding when the equilibrium price is more than the price ceiling. In this case, though the aim is to reduce the inequality such that the need of housing and shelter could be met by even the poorest people.

But it could also result in increased inequality as in the case of applying price ceiling to rented apartments. If the government establishes a minimum of price ceiling on the apartments, there would be an excess demand since it would be less than the equilibrium where the demand and supply meet. This would also mean that at a lower price, the suppliers of apartments would be willing to supply less of the apartments. This would lead to an excess demand and a shortage of supply.

Now when there would be a shortage of apartments, the owners would have the advantage in the market and would either reduce the quality of apartments or would indulge in black marketting of the apartments ie would try to rent the apartments in the parallel market where the apartments could be rented at a higher prices by not registering them in the regular markets.

This would be beneficial for the richer sections of the society, but would leave the poorer ones without shelter and hence would in a way increase the inequality, rather than reducing it.

C) In the figure given below, PF is the price floor. The consumer surplus is given by CS and the producer surplus as PS. the deadweight loss is marked by DWL.

As the total surplus is less than before, this means there is also DWL. It is the loss of the society as a whole ie welfare loss.

This could be seen in terms of minimum wage. If the minimum wage is more than the market wage, there would be less demand of workers as they would be now more costly, but the supply would increase.

This would mean that the ones who are hired are better off because of the higher minimum wage , but there is also more unemployment which would result in deadweight loss.

SOD 250 O 100 200 300 400 500 Quantity

DWL = Area of triangle= 1/2*(b)*h

=1/2*(300-200)*(300-150)

=1/2*100*150= 7500