Price ceiling - Revision history

Vipul: /* Generally, price ceilings reduce seller incentives to prepare for demand and supply shocks, but the story is a little more complicated */

2020-03-31T04:19:24Z

Generally, price ceilings reduce seller incentives to prepare for demand and supply shocks, but the story is a little more complicated

← Older revision		Revision as of 04:19, 31 March 2020
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	Comparing these two, we see that the price ceiling prevents the firm from capturing all the gains in market price. Therefore, even if the firm does increase its production, it will increase it to a lower level (enough for the price ceiling of 2) rather than to the higher level (enough for the market price of 3). Thus, although the firm's long-run planning will alleviate the shortfall a little bit compared to not being prepared at all, the shortfall is still not going to be eliminated.		Comparing these two, we see that the price ceiling prevents the firm from capturing all the gains in market price. Therefore, even if the firm does increase its production, it will increase it to a lower level (enough for the price ceiling of 2) rather than to the higher level (enough for the market price of 3). Thus, although the firm's long-run planning will alleviate the shortfall a little bit compared to not being prepared at all, the shortfall is still not going to be eliminated.

	The above assumes that the firm has definite knowledge of the demand shock. However, the situation gets more complicated when the demand shock is more probabilistic. For instance, if the firm believes that there is some probability that a demand shock will cause the market price to rise to 3. The firm has to choose to reconfigure its fixed costs to gear toward producing enough for the market price of 3, or stay with its current setup, or anything in between. Whatever choice the firm makes, it will have to compare the expected gain from that choice of both the options.		The above assumes that the firm has definite knowledge of the demand shock. However, the situation gets more complicated when the demand shock is more probabilistic. For instance, suppose the firm believes that there is some probability that a demand shock will cause the market price to rise to 3. The firm has to choose to reconfigure its fixed costs to gear toward producing enough for the market price of 3, or stay with its current setup, or anything in between. Whatever choice the firm makes, it will have to compare the expected gain from that choice of both the options.

	Even in this more complicated situation, the presence of the price ceiling reduces, overall, the extent to which the firm will increase its production, by reducing the upside. However, the specifics will depend on other questions such as whether the firm's production cycle, as well as its buyers, can engage in intertemporal substitution.		Even in this more complicated situation, the presence of the price ceiling reduces, overall, the extent to which the firm will increase its production, by reducing the upside. However, the specifics will depend on other questions such as whether the firm's production cycle, as well as its buyers, can engage in intertemporal substitution.

Vipul: /* Generally, price ceilings reduce seller incentives to prepare for demand and supply shocks, but the story is a little more complicated */

2020-03-31T04:18:13Z

Generally, price ceilings reduce seller incentives to prepare for demand and supply shocks, but the story is a little more complicated

← Older revision		Revision as of 04:18, 31 March 2020
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	* Configure their production process so that it is easier to reconfigure quickly (i.e., make the long run less long).		* Configure their production process so that it is easier to reconfigure quickly (i.e., make the long run less long).

	For instance, let's say a firm is one firm among many in a competitive market and an increasing cost industry (we'll assume an increasing cost industry because with a decreasing cost industry, firms are anyway maxed out on production capacity). The market price of a good under normal conditions is 1. The firm correctly forecasts a soon-to-happen demand shock that would cause the market price to go up to 3, ~~with some probability~~. There is a price ceiling of 2.		For instance, let's say a firm is one firm among many in a competitive market and an increasing cost industry (we'll assume an increasing cost industry because with a decreasing cost industry, firms are anyway maxed out on production capacity). The market price of a good under normal conditions is 1. The firm correctly forecasts a soon-to-happen demand shock that would cause the market price to go up to 3,. There is a price ceiling of 2.

	* If there were no price ceiling, the question before the firm is whether to reconfigure its production process to optimize the amount produced for a market price of 3.		* If there were no price ceiling, the question before the firm is whether to reconfigure its production process to optimize the amount produced for a market price of 3.

Vipul: /* Long-run impact of price ceilings */

2020-03-31T04:15:46Z

Long-run impact of price ceilings

← Older revision		Revision as of 04:15, 31 March 2020
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	* Expectations regarding future demand and supply patterns: A price ceiling that is binding today may become non-binding in the future, and a price ceiling that is non-binding today may become binding in the future. Both the normal course of supply-and-demand changes as well as low-probability demand and supply shocks need to be examined in connection with the price ceiling.		* Expectations regarding future demand and supply patterns: A price ceiling that is binding today may become non-binding in the future, and a price ceiling that is non-binding today may become binding in the future. Both the normal course of supply-and-demand changes as well as low-probability demand and supply shocks need to be examined in connection with the price ceiling.
	* Intertemporal substitution with the future: Buyers and sellers who can substitute buying or selling now against buying or selling in the future, have to consider the effect of the price ceiling on how they distribute their buying or selling behavior over time. Note that this long-run consideration can also change the present-day shape of the supply and demand curves, thereby causing a short-run effect.		* Intertemporal substitution with the future: Buyers and sellers who can substitute buying or selling now against buying or selling in the future, have to consider the effect of the price ceiling on how they distribute their buying or selling behavior over time. Note that this long-run consideration can also change the present-day shape of the supply and demand curves, thereby causing a short-run effect.
	* The distinction between short-run and long-run supply, through reconfiguration: In the short run, sellers are generally constrained to a increasing short-run marginal cost curve. In the long run, the seller can change the mix of inputs, for instance, by acquiring more land and capital or hiring more people~~. Long-run supply curves are more likely to be flat or even declining. This complicates the analysis of the impact of price ceilings~~.		* The distinction between short-run and long-run supply, through reconfiguration: In the short run, sellers are generally constrained to a increasing short-run marginal cost curve. In the long run, the seller can change the mix of inputs, for instance, by acquiring more land and capital or hiring more people.

	The type of impact a price ceiling has also depends on its structure. The analysis can differ quite a bit between uniform fixed price ceilings, price change ceilings, and profit ceilings. However, we can say a few broad things.		The type of impact a price ceiling has also depends on its structure. The analysis can differ quite a bit between uniform fixed price ceilings, price change ceilings, and profit ceilings. However, we can say a few broad things.

Vipul: /* Queueing, rationing, and queue-rationing */

2020-03-31T04:14:00Z

Queueing, rationing, and queue-rationing

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	====Queueing, rationing, and queue-rationing====		====Queueing, rationing, and queue-rationing====

	* [[Queueing]] is an approach where buyers are served in some form of a queue. The simplest is a time-based queue (first-come-first-serve) though other forms of priority queue are also possible.		{{further\|[[Queueing, rationing, and queue-rationing]]}}
	* [[Rationing]] is an approach that limits the amount that each buyer can buy.
	* [[Queue-rationing]] refers to a mix of queueing and rationing. For instance, each buyer can buy only a fixed amount in each iteration of purchase, and a buyer can take only one other position in the queue at a time (or even within a time period, for instance, per day). For instance, if the ration is 5 units per purchase, and the buyer wants to buy 48 units, the buyer will have to stand in the queue 10 times.		* Queueing is an approach where buyers are served in some form of a queue. The simplest is a time-based queue (first-come-first-serve) though other forms of priority queue are also possible.
			* Rationing is an approach that limits the amount that each buyer can buy.
			* Queue-rationing refers to a mix of queueing and rationing. For instance, each buyer can buy only a fixed amount in each iteration of purchase, and a buyer can take only one other position in the queue at a time (or even within a time period, for instance, per day). For instance, if the ration is 5 units per purchase, and the buyer wants to buy 48 units, the buyer will have to stand in the queue 10 times.

	A key idea to keep in mind when thinking about these policies (queueing, rationing, and queue-rationing) is that the policies are determined mainly by sellers, but sellers do not internalize most of the gains from selecting policies that improve the efficiency of allocation between buyers. Sellers may, however, gain indirectly through reputational benefits, or spillover benefits to other goods the seller is selling.		A key idea to keep in mind when thinking about these policies (queueing, rationing, and queue-rationing) is that the policies are determined mainly by sellers, but sellers do not internalize most of the gains from selecting policies that improve the efficiency of allocation between buyers. Sellers may, however, gain indirectly through reputational benefits, or spillover benefits to other goods the seller is selling.

Vipul: /* Price ceilings versus quantity ceilings */

2020-03-31T04:12:47Z

Price ceilings versus quantity ceilings

← Older revision		Revision as of 04:12, 31 March 2020
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	=== Price ceilings versus quantity ceilings ===		=== Price ceilings versus quantity ceilings ===

	Both price ceilings and [[quantity ceiling]]s effectively create a situation where the quantity traded is less than it would be without a ceiling. However, quantity ceilings favor sellers over buyers, and also shift the burden of non-price competition to sellers ~~(as~~ sellers compete with each other for permission to produce a larger share of the quantity ceiling.		Both price ceilings and [[quantity ceiling]]s effectively create a situation where the quantity traded is less than it would be without a ceiling. However, quantity ceilings favor sellers over buyers, and also shift the burden of non-price competition to sellers: sellers compete with each other for permission to produce a larger share of the quantity ceiling.

	==Basic theory: the effects of price ceilings in competitive markets==		==Basic theory: the effects of price ceilings in competitive markets==

Vipul: /* Long-run impact of price ceilings */

2020-03-30T00:31:37Z

Long-run impact of price ceilings

← Older revision		Revision as of 00:31, 30 March 2020
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	* The price ceiling is a uniform fixed price ceiling: More complicated price ceiling formulas, like [[price change ceiling]]s and [[profit ceiling]]s, share some qualitative characteristics but are also different in other ways.		* The price ceiling is a uniform fixed price ceiling: More complicated price ceiling formulas, like [[price change ceiling]]s and [[profit ceiling]]s, share some qualitative characteristics but are also different in other ways.
	* The price ceiling is known in advance to the firm: A price ceiling imposed suddenly without warning after a demand shock will have a less detrimental effect on quantity; the firm that had ramped up production has now already invested the fixed costs (thinking it could profit more), and is therefore able to produce more.		* The price ceiling is known in advance to the firm: A price ceiling imposed suddenly without warning after a demand shock will have a less detrimental effect on quantity; the firm that had ramped up production has now already invested the fixed costs (thinking it could profit more), and is therefore able to produce more.

			=== Price ceilings can change the way buyers substitute intertemporally ===

			For goods where present purchases can substitute for future purchases, buyers respond to expectations of future price increases by buying more now. In markets with price ceilings that may become binding, buyers have to factor in not just the future market prices but also future availability. This can change the buyers' decision of how much to buy now, but it's ambiguous in what direction the buyers' behavior will change. Specifically, the way the buyers' behavior changes depends partly on how much each buyer perceives as the costs of non-price competition and how much the buyer's individual reservation price compared with the market price.

			For instance, let's say buyers expect a demand shock or supply shock in the future that would, in a free market, cause the price of toilet paper to rise. This might incentivize buyers to stock up on toilet paper right now. Now, if a price ceiling is implemented that prevents the price of toilet paper from rising, buyers' expectations will shift from an expectation of increased price to an expectation of reduced availability, and the possibility that the buyer may have to engage in non-price competition to get the good. This, too, might incentivize buyers to stock up on toilet paper right now. However, the relative strength of the incentive to stock up on toilet paper, between the free market and price ceiling case, is ambiguous.

			This ambiguity is related to the idea that the effect of price ceilings on consumer surplus is ambiguous (though it's definitely negative for producer surplus and overall economic surplus).

			Note that the possibility of [[black market]]s does increase the incentive to buy and hoard.

	==Related notions==		==Related notions==

	* [[Maximum retail price]] is an upper limit that the producer or wholesale distributor puts on the price at which retailers can sell the commodity to customers. Maximum retail prices do not usually have the inefficiencies associated with price ceilings, because producers of the goods can vary maximum retail prices according to demand trends over the somewhat longer term.		* [[Maximum retail price]] is an upper limit that the producer or wholesale distributor puts on the price at which retailers can sell the commodity to customers. Maximum retail prices do not usually have the inefficiencies associated with price ceilings, because producers of the goods can vary maximum retail prices according to demand trends over the somewhat longer term.

Vipul: /* Long-run impact of price ceilings */

2020-03-30T00:19:42Z

Long-run impact of price ceilings

← Older revision		Revision as of 00:19, 30 March 2020
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	Even in this more complicated situation, the presence of the price ceiling reduces, overall, the extent to which the firm will increase its production, by reducing the upside. However, the specifics will depend on other questions such as whether the firm's production cycle, as well as its buyers, can engage in intertemporal substitution.		Even in this more complicated situation, the presence of the price ceiling reduces, overall, the extent to which the firm will increase its production, by reducing the upside. However, the specifics will depend on other questions such as whether the firm's production cycle, as well as its buyers, can engage in intertemporal substitution.

			Note that this analysis is contingent on some assumptions:

			* The price ceiling is a uniform fixed price ceiling: More complicated price ceiling formulas, like [[price change ceiling]]s and [[profit ceiling]]s, share some qualitative characteristics but are also different in other ways.
			* The price ceiling is known in advance to the firm: A price ceiling imposed suddenly without warning after a demand shock will have a less detrimental effect on quantity; the firm that had ramped up production has now already invested the fixed costs (thinking it could profit more), and is therefore able to produce more.

	==Related notions==		==Related notions==

	* [[Maximum retail price]] is an upper limit that the producer or wholesale distributor puts on the price at which retailers can sell the commodity to customers. Maximum retail prices do not usually have the inefficiencies associated with price ceilings, because producers of the goods can vary maximum retail prices according to demand trends over the somewhat longer term.		* [[Maximum retail price]] is an upper limit that the producer or wholesale distributor puts on the price at which retailers can sell the commodity to customers. Maximum retail prices do not usually have the inefficiencies associated with price ceilings, because producers of the goods can vary maximum retail prices according to demand trends over the somewhat longer term.

Vipul: /* Long-run impact of price ceilings */

2020-03-30T00:16:43Z

Long-run impact of price ceilings

← Older revision		Revision as of 00:16, 30 March 2020
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	* Configure their production process so that it is easier to reconfigure quickly (i.e., make the long run less long).		* Configure their production process so that it is easier to reconfigure quickly (i.e., make the long run less long).

	For instance, let's say a firm is one firm among many in a competitive market and an increasing cost industry. The market price of a good under normal conditions is 1. The firm correctly forecasts a soon-to-happen demand shock that would cause the market price to go up to 3, with some probability. There is a price ceiling of 2.		For instance, let's say a firm is one firm among many in a competitive market and an increasing cost industry (we'll assume an increasing cost industry because with a decreasing cost industry, firms are anyway maxed out on production capacity). The market price of a good under normal conditions is 1. The firm correctly forecasts a soon-to-happen demand shock that would cause the market price to go up to 3, with some probability. There is a price ceiling of 2.

	* If there were no price ceiling, the question before the firm is whether to reconfigure its production process to optimize the amount produced for a market price of 3.		* If there were no price ceiling, the question before the firm is whether to reconfigure its production process to optimize the amount produced for a market price of 3.

Vipul: /* Long-run impact of price ceilings */

2020-03-30T00:15:41Z

Long-run impact of price ceilings

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 The type of impact a price ceiling has also depends on its structure. The analysis can differ quite a bit between uniform fixed price ceilings, price change ceilings, and profit ceilings. However, we can say a few broad things.
 ==Related notions==
 * [[Maximum retail price]] is an upper limit that the producer or wholesale distributor puts on the price at which retailers can sell the commodity to customers. Maximum retail prices do not usually have the inefficiencies associated with price ceilings, because producers of the goods can vary maximum retail prices according to demand trends over the somewhat longer term.

Vipul: /* Long-run impact of price ceiling */

2020-03-29T23:09:58Z

Long-run impact of price ceiling

← Older revision		Revision as of 23:09, 29 March 2020
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	\|}		\|}

	==Long-run impact of price ~~ceiling~~==		==Long-run impact of price ceilings==

	~~===Innovation and substitution between product lines===~~		The long-run impact of a price ceiling is a much more complicated matter than the short-run impact. There are, roughly speaking, three sources of complication:

	~~Price ceilings~~, ~~both binding~~ and non-binding, can ~~have important~~ long-run ~~effects~~, ~~including~~:		* Expectations regarding future demand and supply patterns: A price ceiling that is binding today may become non-binding in the future, and a price ceiling that is non-binding today may become binding in the future. Both the normal course of supply-and-demand changes as well as low-probability demand and supply shocks need to be examined in connection with the price ceiling.
			* Intertemporal substitution with the future: Buyers and sellers who can substitute buying or selling now against buying or selling in the future, have to consider the effect of the price ceiling on how they distribute their buying or selling behavior over time. Note that this long-run consideration can also change the present-day shape of the supply and demand curves, thereby causing a short-run effect.
			* The distinction between short-run and long-run supply, through reconfiguration: In the short run, sellers are generally constrained to a increasing short-run marginal cost curve. In the long run, the seller can change the mix of inputs, for instance, by acquiring more land and capital or hiring more people. Long-run supply curves are more likely to be flat or even declining. This complicates the analysis of the impact of price ceilings.

	* Sellers may choose to rebrand or redefine their products so as to make cheaper or lower quality products that fit in the same category as the original product, or to shift the costs on to auxiliary products. For instance, if a price ceiling ~~is imposed~~ on ~~the sale of cellphones, but what a "cellphone" is is not clearly specified, sellers may shift to stocking more of the cheaper and low cost cellphones~~. ~~Alternatively, sellers may choose to shift costs from the cellphone to the payment plans so they end up selling the cellphones cheap but raise the price of the payment plans.~~		The type of impact a price ceiling has also depends on its structure. The analysis can differ quite a bit between uniform fixed price ceilings, price change ceilings, and profit ceilings. However, we can say a few broad things.
	* Conversely, sellers may be reluctant to create new products in the category for fear that they will not be able to charge a ~~higher price for the new product to recoup the cost of creation. This concern applies even in the case of non-binding~~ price ceilings~~. Goods with high upfront investment costs command a high price at the beginning~~, ~~and sellers then engage in [[~~price skimming]] as competitors catch up, and eventually the new products become as cheap as the older products used to be, and perhaps even cheaper. ''It is thus possible that the existence of a price ceiling scares away innovation that would ultimately have a more beneficial long run impact in terms of reducing cost and improving quality''.

	~~To avoid these, the following are usually done:~~

	* Price ceilings ~~are typically applied for commodities like oil or grain where the unit measurements are reasonably clear and the problem above of a new technology does not arise.~~
	* Sometimes, ~~price ceilings are applied only to certain brands~~ and ~~products and the same sellers are allowed to sell alternate or new products at unrestricted prices.~~

	~~===Disaster planning===~~

	~~Non-binding price~~ ceilings are sometimes put in place to prevent [[price gouging]] in the event of natural disasters. This may reduce incentives for sellers to be well stocked with goods for natural disasters as they will be unable to command the full market price for the good in the event of a disaster.

	~~===Firms in declining-cost industries may leave the market===~~

	There are some industries where the average cost of producing a unit of the good actually declines as more units are produced. This often happens if there are fixed costs of production. The result is that the average cost of producing a unit will exceed the marginal cost of producing a unit, and generally only one firm will supply the market. This is often called a case of ''natural monopoly''. The problem is that when a price control is established that would otherwise raise the quantity sold (as described above), the new price will be below the average cost of producing a unit, and so the monopolist firm will no longer be profitable.

	In order to raise total surplus in this sort of monopoly situation, a price control set at the marginal cost of production will be insufficient. The firm will either have to be allowed to engage in [[price discrimination]] so that the profit-maximizing level of production will be closer to the socially optimal level of production, will have to be subsidized by the government so that it can sell units closer to marginal cost, or will have to be allowed to sell units at or above the average cost of production. This last option has less potential to raise total surplus, as it cannot allow the socially optimal level of production to prevail. However, ~~the other options~~ can also present difficulties, including distributional issues with price discrimination (more of the total surplus is taken up by the monopolist) and funding issues with subsidies (funding subsidies via distortionary taxes can actually create another deadweight loss).

	==Related notions==		==Related notions==

	* [[Maximum retail price]] is an upper limit that the producer or wholesale distributor puts on the price at which retailers can sell the commodity to customers. Maximum retail prices do not usually have the inefficiencies associated with price ceilings, because producers of the goods can vary maximum retail prices according to demand trends over the somewhat longer term.		* [[Maximum retail price]] is an upper limit that the producer or wholesale distributor puts on the price at which retailers can sell the commodity to customers. Maximum retail prices do not usually have the inefficiencies associated with price ceilings, because producers of the goods can vary maximum retail prices according to demand trends over the somewhat longer term.