Supply, Demand and Government Policies
In a competitive market the price is decided by the equilibrium of supply and demand. At the equilibrium
price there is neither excess of demand nor of supply, but sometimes organizations decide to change this
equilibrium for different reasons. For example, an organization decides that prices are too high and wants
to put a stop at a certain level, called price ceiling, or others might think that the price is too low to be
profitable for the sellers so the want to introduce a legal minimum price, called price floor. Price controls
are usually generated when policy makers do believe that the current price is not fair for the customer or
the seller, it could make the trades happen outside the equilibrium and generate inequities.
Price Ceilings
Price ceilings are a legal maximum at which a good or service can legally be sold at. There are two kinds of
price ceilings:
1. Not binding: when the price ceiling is higher than the equilibrium price, so trades can happen
regularly at equilibrium and are still driven by supply and demand.
2. Binding constraint: when the price ceiling is under the equilibrium, so trades can no longer happen
naturally. This situation creates a shortage which makes sellers ration their supplies and selling
according to their bias, creating long lines. This kind of constraint is the example of what would
happen if markets did not normally sell at the equilibrium.
We can notice that in a case of a binding constraint, even though it was implemented in order to help
people who couldn’t afford a certain good at the current price, now people who want that good have to
wait in long lines and might even not get the product at all because now the few products sold at a lower
price are being rationed by sellers and they can also decide who to sell them to, completely depending on
their bias.
, Ex. Rent Control
Rent control is a policy that a government implements when they think that housing costs are too high, and
they want to help the poor by lowering the rents by adding a price ceiling. Initially the policy seemed to
work because supply and demand in the short term are inelastic, so supply remained the same and demand
increased slightly, generating only a very small shortage. In the long run supply and demand became elastic
because landlords weren’t building any more houses because the could hardly maintain their own and it
was so hard to find a rental that many people decided to get a mortgage and buy their own. This created a
severe shortage in rental houses, so even though the original intentions of the policy were good, this policy
was highly inefficient.
Price Floors
The price floors are the legal minimum at which a good or service can be legally sold at. Also in this case
there are binding and not binding scenarios:
1. Not binding: the price floor is positioned under the equilibrium price, so trades can be carried out
normally based on supply and demand.
2. Binding: the price floor is placed above the equilibrium price generating a surplus. This can create a
rationing mechanism but this time not from the seller but the buyer. The buyer can appeal to their
personal bias and buy from the sellers of their same ethnicity, family, origin, and much more.
Ex. Minimum Wage
When the minimum wage is risen many people will drop what they were doing to start working. Many
teenagers, for example, drop out of school to start working early because of the increased minimum wage,
but this generates a surplus of workers with fewer jobs than before, even if these jobs are going to be paid
more. So, ultimately, every rise in minimum wage will raise unemployment, because it moves the price
from an equilibrium price where everyone who desired to work had the possibility to so, to less be tter paid
In a competitive market the price is decided by the equilibrium of supply and demand. At the equilibrium
price there is neither excess of demand nor of supply, but sometimes organizations decide to change this
equilibrium for different reasons. For example, an organization decides that prices are too high and wants
to put a stop at a certain level, called price ceiling, or others might think that the price is too low to be
profitable for the sellers so the want to introduce a legal minimum price, called price floor. Price controls
are usually generated when policy makers do believe that the current price is not fair for the customer or
the seller, it could make the trades happen outside the equilibrium and generate inequities.
Price Ceilings
Price ceilings are a legal maximum at which a good or service can legally be sold at. There are two kinds of
price ceilings:
1. Not binding: when the price ceiling is higher than the equilibrium price, so trades can happen
regularly at equilibrium and are still driven by supply and demand.
2. Binding constraint: when the price ceiling is under the equilibrium, so trades can no longer happen
naturally. This situation creates a shortage which makes sellers ration their supplies and selling
according to their bias, creating long lines. This kind of constraint is the example of what would
happen if markets did not normally sell at the equilibrium.
We can notice that in a case of a binding constraint, even though it was implemented in order to help
people who couldn’t afford a certain good at the current price, now people who want that good have to
wait in long lines and might even not get the product at all because now the few products sold at a lower
price are being rationed by sellers and they can also decide who to sell them to, completely depending on
their bias.
, Ex. Rent Control
Rent control is a policy that a government implements when they think that housing costs are too high, and
they want to help the poor by lowering the rents by adding a price ceiling. Initially the policy seemed to
work because supply and demand in the short term are inelastic, so supply remained the same and demand
increased slightly, generating only a very small shortage. In the long run supply and demand became elastic
because landlords weren’t building any more houses because the could hardly maintain their own and it
was so hard to find a rental that many people decided to get a mortgage and buy their own. This created a
severe shortage in rental houses, so even though the original intentions of the policy were good, this policy
was highly inefficient.
Price Floors
The price floors are the legal minimum at which a good or service can be legally sold at. Also in this case
there are binding and not binding scenarios:
1. Not binding: the price floor is positioned under the equilibrium price, so trades can be carried out
normally based on supply and demand.
2. Binding: the price floor is placed above the equilibrium price generating a surplus. This can create a
rationing mechanism but this time not from the seller but the buyer. The buyer can appeal to their
personal bias and buy from the sellers of their same ethnicity, family, origin, and much more.
Ex. Minimum Wage
When the minimum wage is risen many people will drop what they were doing to start working. Many
teenagers, for example, drop out of school to start working early because of the increased minimum wage,
but this generates a surplus of workers with fewer jobs than before, even if these jobs are going to be paid
more. So, ultimately, every rise in minimum wage will raise unemployment, because it moves the price
from an equilibrium price where everyone who desired to work had the possibility to so, to less be tter paid
