Economics Micro & Macro (CliffsAP)

■ When the demand curve shifts to the right and the supply curve stays constant, there is an increase in price and an

increase in quantity.

■ When the demand curve shifts to the left and the supply curve stays constant, there is a decrease in price and a

decrease in quantity.

Price Floors and Price Ceilings

A price flooris a government-mandated minimum price for a good or service. An example of a price floor is the mini-
mum wage. Producers may not pay below the legal minimum in wages for labor.

A price ceilingis a government-mandated maximum price for a good or service. An example of a price ceiling is rent
control. A landlord may not charge over the legal maximum in rent.

The government uses price ceilings and price floors because in some instances when supply and demand intersect it is
not beneficial to society as a whole. When this occurs, the government intervenes and sets a price floor or ceiling to
purposefully create a surplus or shortage.

For a price floor to be effective, the government must set the legal minimum abovethe equilibrium price. For a price
ceiling to be effective, the government must set the legal maximum belowthe equilibrium price. Both of these points
are illustrated in Figure 2-7.

Figure 2-7

Notice that the price floor automatically creates a surplus because price floors are typically higher than the equilibrium
price. If a higher price is established, then according to our law of demand, fewer people will consume and a surplus will
result. Price floors can be a useful tool for rationing by the government. If demand becomes too great in any instance,
a price floor would eliminate any shortage by promoting a higher price.

A price ceiling, on the other hand, creates a shortage. With a shortage, the government can promote or encourage demand
for a specific good or service. Primarily, the government introduces a price ceiling in an attempt to level the playing field
for consumers. If the government applies a price ceiling, it typically means that the forces of supply and demand are
becoming a social costrather than a social benefit.

Ineffective price floors and ceilings are usually placed below the equilibrium price. When this is done, the supply or
demand isn’t changed because the market clearing price takes precedence over any artificial price. For a price floor
or ceiling to be truly effective, floors must be placed above the equilibrium price and ceilings must be placed below
the equilibrium price.

6$

4$

Price

Price Floor

Quantity

Price

Floor

Eq

800

1,000

Price

Price Ceiling

Quantity

Price

Ceiling

(^00) Eq
Part I: The Fundamentals