The cross-price elasticity of demand measures how the quantity demanded of one good responds to a change in the price of another good. It can be calculated by dividing the percentage change in quantity demanded of the first good by the percentage change in the price of the other good.
Substitutes have positive cross-price elasticity and complements have negative cross-price elasticity.
Until now, we haven’t involved the government at all. In a free, unregulated system, the market forces establish equilibria. While they may be efficient, it needn’t be true that everyone is satisfied in this case. It is the economists’ duty to use theories to assist the development of policies.
Price control is enacted only when these policy-makers believe that the market price is unfair to either the buyers or the sellers. This results in price ceilings (legal maximum price) and floors (legal minimum price).
The price ceiling is said to be binding if it is set below the equilibrium price and not binding if it is set above the equilibrium price. In a competitive market, a binding ceiling results in a shortage and the sellers must ration the scarce goods among the large number of potential buyers.
For example, rent control policy helps the poor by making pricing more affordable (for the poor).
It is worth noting that rent control is usually considered terrible by economists (despite it sounding good to the general public). As with any binding price ceiling, rent control results in a shortage in the long run. On the supply side, landlords are unmotivated to build new apartments and do not maintain the existing ones. On the demand side, people are encouraged to go out and find a place to live. Further, since there is no incentive for landlords to respond to their tenants’ demands, the quality of housing goes down as well. This problem does not show itself in the short run.
An example of a price floor is the minimum wage that is usually present. Similar to rent control, this causes unemployment in the long run. This might be the only reason internships even exist; inexperienced people (teenagers) are willing to work for nothing (since this circumvents minimum wage).