3. What do economists mean when they say that \"price floors and ceilings stifle
ID: 1250993 • Letter: 3
Question
3. What do economists mean when they say that "price floors and ceilings stifle the rationing function of prices and distort resource allocation"? Use the ideas of consumer surplus and producer surplus to explain why economists say competitive markets are efficient. Why are below-or above-equilibrium levels of output inefficient, according to these two sets of ideas?4. What is the purpose of charging different groups of customers different prices? Supplement the three broad examples in the Last Word with two additional examples of your own.
Explanation / Answer
3. "What do economists mean when they say that "price floors and ceilings stifle the rationing function of prices and distort resource allocation"?" Price controls prevent buyers who are willing to purchase at a price from buying from sellers who are willing to sell at that price. The fact that the buyer is willing to buy and the seller is willing to sell is evidence that they would both benefit from the transaction, assuming each is acting rationally. But a price control prevents them from making the transaction and receiving this benefit. Thus, it stifles the rationing function of prices. Because the buyer isn't aloud to buy at the desired price and the seller isn't aloud to sell at the desired price, the buyer will use his or her money to buy other things and the seller will produce other things. In this way, resource allocation is distorted. "Use the ideas of consumer surplus and producer surplus to explain why economists say competitive markets are efficient." A reservation price is the highest price a consumer is willing to pay for a quantity. A demand curve reflects a consumer's reservation price. Consumer surplus from a unit of consumption is equal to a consumer's reservation price minus the actual price. The producer surplus from a sale is equal to the price minus the marginal cost. We say an outcome is efficient if it represents a maximum of total surplus. At the competitive equilibrium, the consumer purchases all quantities where the consumer's demand curve (his or her reservation prices) is greater than the price. The producer sells all quantities where the price is above the marginal cost. Quantities are not purchased if the price is above the demand curve and not sold if the marginal cost is above the price. In this way, the competitive equilibrium is efficient because it represents a maximum of total surplus. "Why are below-or above-equilibrium levels of output inefficient, according to these two sets of ideas?" If a quantity is below the equilibrium quantity, this implies that there exist quantities where the demand curve is above the price and/or the price is above marginal cost. This implies that total surplus would increase if the quantity was larger. Thus, quantities below equilibrium are inefficient. If the quantity is above the equilibrium, this implies that, at this quantity, the marginal cost is above the price and/or the price is above the demand curve. Thus, total surplus would increase if the quantity was decreased. Thus, quantities above equilibrium are also inefficient. 4. "4. What is the purpose of charging different groups of customers different prices? Supplement the three broad examples in the Last Word with two additional examples of your own." The purpose of charging different groups different prices is to increase a firm's profit. If different groups of consumers have different elasticities, a firm can increase profit by charging a higher price to the group with the lower elasticity. This is true because having a higher elasticity means that the consumer will decrease his or her consumption less when charged a higher price. I don't know which examples were used in the Last Word, so I hope I am not duplicating them. But here are two classic example. Movie tickets. Old people have a higher elasticity of demand for movie tickets than youngsters. So, old people receive a senior discount Similarly, students have a higher elasticity of demand and receive a discount. We know this is price discrimination because the marginal cost of showing a movie is not different depending on the age of the person watching the movie. Cars. Car dealers post sticker prices, but it is well-known that very few people pay sticker prices. In fact, most people receive discounts or "deals." In has been shown that car dealerships tend to charge a higher price to white people than they do to blacks or Hispanics (controlling for other variables such as income) even though the marginal cost of the car is the same. This is because whites have a lower elasticity of demand for cars than do blacks or Hispanics. Thus, car dealerships profit from price discrimination.
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