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5.b The Effects of Price Ceilings: S P Black Market Price
5.b The Effects of Price Ceilings: S P Black Market Price
5.b The Effects of Price Ceilings: S P Black Market Price
Pb =$0.85
$0.65
40 cent
waiting
time
Pc =$0.45
45 cent cash
10u shortage
D
8
12
18
Q-oil
Figure 5.b.1 There was an oil shortage because there was a price ceiling $0.25 less than the natural market price,
which means it was binding. People who want gas are going to pay $0.45 in hard cash and they are going to pay
$0.40 in waiting time. So when the scalper comes along, he or she is charging the customer $0.85 (found by tracing
a line from the quantity supplied up to the demand curve), which is the price that customer is paying while waiting
in line.
Example: Rent Control
When considering rent control, in order to compare the importance of different pros and cons, the economist assigns
dollar values, resulting in cost-benefit analysis. Rent control is an interference to free trade because it places a legal
maximum price for rent. In most cases, the price ceiling is set below the natural equilibrium price in order to make
the apartment or house more affordable to poorer people. Because of the binding price constraint, a shortage occurs.
Take a look at Figure 5.b.2.
$600
P c=$500
150 u
shortage
500
D
Q- Houses
650
Figure 5.b.2 With a vertical supply of houses curve at 500, the natural equilibrium price of each house is $600.
However, when the government imposes a price ceiling (Pc) of $500, it is a binding constraint. At $500, the quantity
demanded is 650. The supply is only 500. Since the quantity demanded exceeds the quantity supplied, there is a
shortage of 150 units.
This shortage triggers a series of unintended consequences. Normally, the landlord would water the grass,
paint the walls, and take care of the house because he or she wants people to rent the house. Since the price ceiling
causes excess in the quantity demand, the landlord does not have to try hard to get the house rented out. Therefore,
the grass is not watered and the appearance withers. Eventually, the neighborhood may become poorer and poorer
until it becomes unhealthy and the government takes over the land. So the price control was set up to help the poor,
but it might have taken them off their property. Figure 5.b.3 illustrates surpluses.
P
$800
S
CS before the
ceiling =$50,000 (A)
A
PS before the
ceiling
=$300,000 (B+C)
$600
CS after the
ceiling =$100,000 (A+B)
B
Pc=$500
C
D
500
650
Q- Houses
Figure 5.b.3 The consumer surplus (CS) before the price ceiling can be found as the area below the demand curve, above the price, and
left of the quantity bought (A) [(200*500)/2=$50,000]. After the price ceiling was imposed, CS rose by area B
[50,000+(100*500)=$100,000]. The producer surplus (PS) before the price ceiling can be found as the area above the supply curve,
below the price, and left of the quantity sold (B+C) (600*500=$300,000). After the price ceiling, PS shrunk by area B [300,000(100*500)=$250,000].
Since rent control causes shortages of houses, why then does the government impose it? If you live in a place where the natural
market price is higher than the ceiling price, you are definitely going to vote for the ceiling so that you can pay a lesser price. Also,
it is very politically unpopular to allow the price of houses to go up to fix the shortage problem.