The Upside-down Economics of Regulated and Otherwise Rigid Prices - PowerPoint Presentation

The Upside-down Economics of Regulated and Otherwise Rigid Prices by Casey B. Mulligan and Kevin K. Tsui

Types of price regulation Joint price-quantity regulation Conscription = price ceiling + supply mandate Price ceiling with limits on purchasingPrice floor with limits on sellingPrice regulation aloneThis paper emphasizes ceilings rather than floorsmuch of health, (some) rent control, insurance, bankingCompetition occurs on non-price dimensions

Figure 1. Claims on gross tenant-occupied housing output, 2006

Creating more square feet with the same cubic feet

Industry Tastes and Technology Technology g (n,q) = cost of producing quantity n with non-price attributes qY(n,q) = services produced by n and q positive first derivatives and positive cross derivativescomparative statics are the same replacing q with F ( q ), F  > 0 Tastes: u (Y, all other goods) = consumer utility. Linear in AOGDerivative summaries at a point {n,q} u :  = magnitude of price elas. of the demand for Yg: = “elasticity of supply of quality” > 0 gnn describes the supply of quantityY:  = elasticity of subs. (and rts) > 0g & Y: cxY, related to expansion pathu, g, Y: “Market multiplier” β (u does not contribute much)    

n q Scale effect Substitution effect Isoquants of Y ( n , q ) Expansion path Figure 2. Scale and substitution effects on the services delivered by the controlled good.

Equilibrium concepts Quality-regulated equilibrium No restrictions on prices Market determines quantity nPrice-regulated equilibriumProducers choose a quality limit x, but prices must complyConsumer choose n (and q), given the quality limitBoth are competitive The two are isomorphic, UNLESS the quality ceiling increases the equilibrium price  

Supply with efficient quality Services demand   Figure 4 B. The services provided by the controlled good, with separable conditional cost: supply shift is second order. Services amount Services price 0

A Price Ceiling Causes Inefficiently Low Quantity 1.6 0 1.8 2.0 2.2 2.4 $1,400 1,200 1,000 800 600 Quantity of apartments (millions) Monthly rent (per apartment) D S E Deadweight loss from fall in number of apartments rented Price ceiling Quantity supplied with rent control Quantity supplied without rent control

  Figure 3. The demand for raw quantity with a quality ceiling . Raw quantity ( n ) Price of quantity         (As drawn), , producers benefit from dq < 0   Which is a better substitute for quality (at the margin): Quantity? ( ) Other goods? ( )     0

The demand for raw quantity with various quality ceilings .  

Raw quantity ( n ) Price of quantity           vs   i.e., vs   Producer surplus and the supply of raw quantity with a quality ceiling.  

Joint production interpreted     Cost of raw quantity   Cost of adding quality     Factor-supply curves:    

Producer surplus and the supply of raw quantity with a quality ceiling. Raw quantity ( n ) Price of quantity         extra surplus

Factors for adding quality Factors for producing raw quantity   F actor quantity Factor supply F actor price     F actor quantity Factor supply F actor price     Quality regulation changes the composition of producer surplus .

Quality coordinates supply and demand given price Price coordinates supply and demand given quality quantity Supply price quantity 1/quality Is quality a pseudoprice ? Demand Supply Demand

quantity 1/quality Is quality a pseudoprice ? Supply Demand There is likely a region where demand slopes up   unstable   Note : p is held fixed.  

    Price regulation: compliance becomes interdependent An example with elastic quality supply. w n is the factor price for Z n MC pricing Market supply of quantity   A ggregate consistency market quantity N depends on market quality Q Own quality supplied     Interdependent compliance efforts

Supply with efficient quality   The market multiplier i llustrated with a quality ceiling. Raw quantity Price of quantity Supply with regulated quality   m m = ratio of red to green (at the margin)

Market multiplier: as a function of tastes and technology Equilibrium quantity change per unit dx Supply-curve shift per unit dx (quantity dimension)    

  Quality Price ceiling               Figure 5A. Equilibrium quality vs. the price ceiling The role of the market multiplier      

  Raw quantity Price ceiling                 Figure 5B. Equilibrium quantity vs. the price ceiling The role of the market multiplier, assuming g nn > 0      

U Quality Price ceiling     Figure 5C. Equilibrium quality vs. the price ceiling Example: the multiplier exceeds one at the unregulated allocation           R

U Quality Price ceiling Equilibrium quality vs. the price ceiling Example: the multiplier is almost one at the unregulated allocation       R

Market multiplier: a pecuniary externality becomes a true externality     Lagrangian for a “planner” who faces a limit p on marginal cost The market ignores this piece  possible death spirals Planner’s benefits and costs of quantity

Ceiling increases quantity ( )   Q uality reduces WTP   Unstable (   Necessary and sufficient conditions

Ceiling increases quantity ( )   Q uality reduces WTP   Unstable (   Jevons Paradox

Producer surplus and the supply of raw quantity with a price ceiling. Raw quantity ( n ) Price of quantity       extra surplus      

p u  p r Impact of regulation Figure 6. Qualitative effects of price regulation by the market multiplier value at the unregulated allocation 0 x w/ mm < 1 n , pn w/ mm < 0 u w/ mm < 1 u , ( u + g – pn ), x w/ mm ≥ 1 n, pn w/ mm ≥ 1 n w/ mm  (0,1) Definitions n = quantity p n = expenditure x = quality limit u = social surplus g = total cost m m = market multiplier p u = unregulated price p r = regulated price  = elasticity of q supply Note : Assumes that supply is not perfectly elastic ( pn  g ) w/ mm  (1/(1+  ),1 ) ( pn – g ) w/ mm < 1/(1+  )

p u  p r Impact of regulation Figure 6. Qualitative effects of price regulation by the market multiplier value at the unregulated allocation 0 n , pn w/ mm < 0 n, pn w/ mm ≥ 1 n w/ mm  (0,1) Definitions n = quantity p n = expenditure x = quality limit u = social surplusg = total costmm= market multiplierpu = unregulated pricepr = regulated price = elasticity of q supplyNote: Assumes that supply is not perfectly elastic

Figure 4 B. The services provided by the controlled good, with separable conditional cost: Y -supply shift is second order. Figure 4A. The raw quantity of the controlled good, with quality regulation and on the relevant parts of demand.   Supply with efficient quality Services demand   Services amount Services shadow price Supply with inefficient quality   Supply with efficient quality Willingness to pay   Raw quantity p Supply with regulated quality  

Price regulation comparative statics          

Waiting Model 1: a symptom of low inventories q = vacancy rate, a.k.a., inventory ratioThe resource cost of the vacancy rate q is proportional to n.Vacancy rate goes in Y(n ,q) because it enhances the average value of the units consumed. E.g., fewer stockouts. If Y ( n , q ) = nf ( q), then . Model 2: Customer in the production function “Revenue misspecification” problem Model 3: First-come, first served; lotteries; waiting taxWould not be an equilibrium outcome in our model, unless these mechanisms reduced marginal costs 

Summary Quality competition with homogeneous buyers and sellers A price ceiling can increase the quantity traded It increases supply, andby increasing demand () or by not decreasing it too much. Not a litmus test for imperfect competitionA price ceiling can increase expenditure A price ceiling can benefit producers A price ceiling can create worse-than-first-order losses