Research / BFI Working PaperMay 01, 2016

The Upside-down Economics of Regulated and Otherwise Rigid Prices

A version of the Becker-Lancaster characteristics model featuring quality-quantity tradeoffs reveals a number of surprising market behaviors that can result from price regulations that are imposed on competitive markets for products that have adjustable non-price attributes.  Quality need not clear a competitive market in the same way that prices do, because quality can reduce the willingness to pay for quantity. Producers can benefit from price ceilings, at the expense of consumers.  Price ceilings can result in quality-degradation “death spirals” that would not occur under quality regulation or excise taxation.  The features of tastes and technology that lead to such outcomes are summarized with pairwise comparisons of (not necessarily constant) elasticities.

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