Solution Manual for Principles of

Microeconomics 7th Edition Gottheil

1285064445 9781285064444
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Chapter 6: Price Ceilings

and Price Floors

Chapter Outline

The Fishing Economy, Once Again

Now, a National Security Crisis
Mobilizing Fishermen

Who Can Afford a $10 Fish?

Setting a Ceiling on Price
Living with Chronic Excess Demand

Price Ceilings and Ration Coupons During World War II

Did the Price Control System Work?
There’s Also Reason for Price Floors

Setting a Floor on Price

Living with Chronic Excess Supply
Agriculture’s Technological Revolution

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The Effect of Technological Change on Agricultural Supply

To Intervene or Not to Intervene: That Is the Question

Parity Pricing As a Price Floor

The Invention of Parity Pricing
History of Government Farm Bills

The Freedom to Farm Act of 1996

The Farm Bill of 2008
A Long Tradition of Price Ceilings and Price Floors

What the Chapter’s About

This chapter is basically a review exercise in supply and demand analysis, focusing on
policy applications. The only new concepts introduced are price ceilings, price floors, and
parity pricing. Each is imposed on markets that generate nonacceptable equilibrium
prices.
The chapter begins where Chapter 3’s analysis of the fish economy left off. The
student knows that supply and demand determine equilibrium prices; that the fish market
is in equilibrium because at $4, the quantity demanded of fish equals the quantity of fish
supplied. The student also knows that if price changes, we look as a rule to either changes
in demand or changes in supply.
This chapter examines exceptions to the rule governing market prices. These
exceptions are important. After all, we live in a world where interference with market-
determined prices is a fact of life. Our federal, state, and local governments, prompted by
special interest groups, have intervened in a multiplicity of markets to legislate prices that
differ substantially from market-determined prices.
The chapter analyzes the effects of price ceilings and price floors on price and quantity.
By the end of the chapter the student should know why we sometimes tamper with
equilibrium prices and, at the same time, acquire a firm understanding of the role market
prices play as a rationing mechanism.
Why would anyone want government to interfere with market-derived equilibrium
prices? Consider a threat to national security. Government’s mobilization for war
preparedness shifts resources from civilian goods to military goods production. As a result,
the price of fish, along with most other prices, increases (in the text’s scenario, from $4 to
$10.) For some people, that’s too high a price to pay for fish. The high price cuts many
people out of the market. The question is: So what? They are probably cut out of the
market for $60,000 Porsches as well. Why worry about a $10 fish? Work over this
question. It gives you the opportunity to address the ethical and political issues involved
and leads directly into the economic history of price controls.

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A second fishing scenario creates a new and different problem. Suppose a bumper
harvest of fish cuts equilibrium price from $4 to $2. This time, it’s a crisis for fishermen.
After all, who can make a living off a $2 fish? Again, the question invites discussion of
ethical and political issues and leads directly to the history of American agriculture. The
student learns how government-imposed price floors create surpluses.
The story of agriculture is a good vehicle to bring into discussion price and income
elasticities, technological change, and the invention of parity pricing.
Suggestion: You can strike close to the student’s heart by discussing college tuition.
How many of your students would choose to have tuition—the price of their college
education—determined by market forces? How many would prefer to have government
intervene on their behalf? Why? And what are the economic consequences of price
ceilings on tuition and admission to college? Do they realize that tuitions at most state
universities and most community colleges are fractions of tuitions charged at private
institutions? Even private institutions have been helped considerably by government.
This may also be a good place to discuss what a tariff is, and show how it changes the
price students pay for Italian bikes. Ask if they have read anything about minimum wages.
It will show them how relevant this chapter is to their economic lives.

Basic Economic Concepts

This chapter is designed to show the effect of government intervention in the market. The
two government-imposed price deviations from equilibrium price are price ceilings and
price floors. Because price ceilings create shortages in the market (excess demand at
the government-imposed ceiling price), ration coupons are sometimes used, replacing
price as the rationing mechanism in the market. Prime examples of price floor legislation
are found in the agricultural industry. Government invented parity pricing to enable the
farm population in our economy to maintain its purchasing power vis-à-vis the nonfarm
population.

Using the Economic Consultants Feature

You can turn this Economic Consultants feature into an assigned project for the class.
Each student can prepare the report on some of the aspects of the farm economy, or
specific segments of the topic can be assigned to a student or group of students to create
a collective project for the class. The topic here is the economics of agriculture
cooperatives. They are the suppliers and the question raised is this: How can they improve
their market positions? In pursuing this question, students will discover the dominant role
that government plays. Students can pick different farm industries to develop their
research reports.

Answers to Text Questions

1. The problem doesn’t disappear. It changes character. Suppose a homeless person
cannot pay the $300 rent on low-quality housing. Along with others, he spends nights
sleeping in public parks, store fronts, or on the sidewalk. Unacceptable? Suppose

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the government considers the $300 rent too high and imposes a price ceiling at $50.
Is this homeless person satisfied? He may now be able to afford the $50 rent. The
quantity demanded of low-quality housing increases. But fewer housing units are
supplied at $50. The result? An excess demand for housing emerges at $50 and the
homeless person may now find himself homeless not because rent is too high, but
because he cannot find available units at $50.

2. Price ceilings are more practical than price floors because the issue typically is rising,
not falling, prices. The reason they rise is because resources have been shifted from
civilian to wartime production.

3. (a) The government-imposed price floors have generally resulted in higher than
equilibrium prices and higher incomes for farmers. Parity pricing was designed
to prevent farmers’ purchasing power from falling. That is, government
intervention does not explain why farmers fare poorly.
(b) If the government established parity at 100 percent and bought up the farm
surpluses, farmers’ incomes would increase, but only at the expense of others.
Higher taxes would be needed to finance the government’s purchase of the
surplus.
(c) This seems to be the most reasonable answer. Low price elasticity of demand
and low income elasticity of demand combines with incessant technological
change over the years to produce agricultural prices that fall relative to
nonagricultural prices. The government cannot change these basic market
forces.

4. The culprits are the inelastic demand for farm goods and the incessant technological
changes in agriculture that shift the supply curve further and further to the right,
lowering prices and raising quantities sold. Because the demand curve is inelastic,
the revenue generated by the increased sales does not compensate for the decrease
in revenue caused by the falling price. The result? Falling incomes.

5. Farmers lose. They will face lower prices and most will earn less income. In some
cases, farmers will be forced to leave their farms. Consumers gain. Lower food prices
raise their real incomes. Also, raw material prices, such as cotton prices, will fall. The
supply curves of goods made with these raw materials will shift to the right. As a
result, their prices will fall. In this way, too, consumers gain. Finally, with government
no longer buying up farm surpluses, taxes will be lower, and consumers gain on this
account as well.

6. A parity price is the price at which a farm good would have to be sold to enable the
farmer to buy with that good the same quantity of nonfarm goods bought in previous
years. Parity pricing works by fixing the ratio of prices of farm goods to prices of
nonfarm goods. The rationale for parity pricing is to maintain the farmers’ purchasing
power vis-à-vis the purchasing power of the nonfarm population.

7. Minimum wage rates are government-imposed wage rates that substitute for
equilibrium wage rates. The minimum wage is a price floor. A case for? It raises
incomes of people who earn less than the minimum wage. A case against? It may
create unemployment.

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8. Usury laws set price ceilings on interest rates. From time immemorial, people in
situations of economic distress have had to borrow money to survive. Frequently,
moneylenders took advantage of the borrowers’ situations and charged interest rates
so exorbitant it became impossible for borrowers to repay their debts. This outcome
promoted social and political instability. The biblical narrative is replete with
admonitions against usury. Plato and Aristotle were also concerned about political
instability and identified usury as a principal contributing factor. They, too, advocated
the prohibition of usury.

9. The price ceiling would lower fish prices, but would also create a shortage of fish.
The lower price would draw demanders away from meat and fowl, but the persistent
shortage may force would-be fish demanders back to meat and foul.

10. Ration coupons are typically coupled with price ceilings because price ceilings
generate excess demands. The question then becomes one of how to allocate the
lesser quantity supplied among the greater quantity demanded. Among alternative
allocative mechanisms is the ration coupon. The quantity of coupons printed should
equal the quantity of the good supplied at the price ceiling. How the coupons are
distributed is another matter. A consumer makes a purchase with the coupon and by
paying the ceiling price.

Answers to Practice Problems

1. The effect of a $20 price ceiling: Price is $20, quantity demanded is 550, quantity
supplied is 350. The effect of a $10 floor: Price is $30; quantity demanded and
quantity supplied is 450.

2.
Parity price ratio
1990 100.00
1991 84.00
1992 68.75
1993 60.50

The Commodity Credit Corporation’s loans would tend to increase year by year.

3.

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Parity price ratio

120
100
80
60 Series1

40
20
0
1990 1991 1992 1993

4. Check Web

5. Check Web

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