Shortages & Surpluses: Why price floors and price ceilings don’t work in markets

A shortage happens when there is more of a demand for a good than there is supplied. One way shortages occur is through a price ceiling. 

An example of a price ceiling we can use to explain the concept would be rent control. Imagine if you had to rent out the front apartment of the farm for half of what you wanted to rent because of some new law Obama made. (That’s important: government make the ceiling, not the free market) Say you have to only charge $800. First of all, this price is what we now call binding. Even if someone was renting an apartment for $600 a month, they’d now charge $800 because that’s the most they could get. So now at this new price, everyone will want to rent from you since it’s so cheap. That’s great! But you still have to pay for the upkeep of the apartment, put in a new stove if they need one, things like that. For some people, it’s not going to be worth it to rent out that apartment anymore. It might be cheaper to sell the building all together, to tear down the building, or to live in it themselves. So even though there’s a lot of demand for this cheaper housing, a lot of the supply of rentable spaces declines (quantity supplied) and is no longer able to be rented. This creates an artificial equilibrium. This hurts this market in the long run as well. The quality of houses still being rented will probably be in more disrepair since it’s not really worth the upkeep anymore. You’ll probably have people now blackmailing or bribing landlords to get into the few rentable houses still up for rent, and eventually the dilapidated houses will fall apart, causing even smaller of a supply. Moral of the story? Don’t mess with the natural market.

A surplus occurs when there is more of a supply of a good than is demanded by consumers. This happens when government puts into place a price floor.

Another good example to explain a price floor would be the agriculture market. Remember hearing stories about the government paying farmers to not grow crops? Or buying up some of their crop for a high price? That’s what a price floor is. The government puts into place a minimum price for a good that consumers must pay, which decreases the quantity demanded since the good is more expensive, and increases the amount suppliers are willing to sell since they’re getting a higher price. This actually creates an artificial equilibrium, as well as a huge problem with crop markets in foreign countries. The government purchases huge amounts of crops from farmers to cut down on the surplus and sells them to famine relief in famine countries. Unfortunately, the transport of these crops is really inefficient, and so by the time the influx of cheap crops occurs, the famine is over and farmers have actually started supplying again, putting those farmers out of business just as they’ve recovered from a famine.

Notice that in both of these situations, price floors and price ceilings affect quantity demanded and quantity supplied along each curve. They do not move the specific curve. 

The Basics of Microeconomics: Everything you need to know about supply and demand

Microeconomics is basically the study of individual choices in markets. Instead of looking at whole countries and their economic performance, we focus on individuals and how the market affects them.

Supply (the red line)  is the amount producers are willing to sell at different prices. The keyword here is willing. Since the supply model is just a model, we cannot say for sure what producers will actually produce. We are speaking in hypothetical terms here. It makes sense then that as the price a producer can get for a good goes up, the more the producer will be able to make, since they’re getting more money for it. That’s why the slope of the supply line is positive.

Demand (the blue line)  is the amount consumers desire to consume, backed by their purchasing power. Again, the key word is desire. Just because a consumer wants something does not mean they will get it. You’ll notice that in your every day decisions, the law of demand plays out. IF the price of cat food goes up, you’ll most likely start thinking about feeding your cats more leftovers from you and Poppy instead of shelling out more money for the same amount of Purina. That’s why the slope of the demand line is negative: as a consumer has to pay more for a good, they’ll want less of it.

Keep in mind: Supply and Demand relationships do not need to be linear. However, economists like to make pretty graphs, so it is easier to show the relationship this way.

Two other terms are very important here: Quantity Supplied and Quantity Demanded.  These two terms are similar to Supply and Demand, but are changed by different things.

Let’s start with the difference between Demand and Quantity Demanded. Demand can be changed by a lot of things, including expectations, income, population, the price of substitution goods and complementary goods, and preferences. For example, if you get a bonus at work and your income goes up, you’ll likely be able to afford a lot more. Maybe you can finally afford that new cell phone you wanted, or even a new car! Therefore, your demand for goods will increase, making the line on the supply demand graph extend out. These other conditions, called parameters change demand in similar ways. For example, if the price of hot dogs skyrockets, the demand for mustard (a complementary good) will go down, and the demand for cheeseburgers (a substitute good) will probably go up, since hot dogs are more expensive than burgers now.  Parameters move the whole demand curve out or in, depending on what exactly is happening, while price stays the same. This is important. Parameters change demand, keeping price the same. For quantity demanded, price changes, and the parameters are kept constant. When the price changes, we can move along the demand curve right where it is, no need to move it around.

Supply and Quantity Supplied are very similar. Supply gets changed by different parameters, though. Supply is affected by the number of suppliers, cost of production, technology, expectations, and weather. For example, everyone uses computers nowadays to order things online, making it way easier for companies to get orders and organize stock, making it easier for them to supply things, as they don’t have to pay someone to go through each order by hand. Supply well then move out since technology has made is easier and cheaper for producers to produce. Just like before, supply is affected by parameters while price is held constant. Quantity supplied is affected by price, all else equal.