Effect of Price Controls
An applet for studying the effect of price floors and ceilings. Created by Ben Gaines, Marie Hull, Lily Liu, and Rosen Valchev for GS 760 in Spring, 2014.
1. What are the equilibrium price and equilibrium quantity in this market? 2. Calculate consumer surplus (CS), producer surplus (PS), and total surplus (TS) at this price. [Consumer surplus is the area between the demand curve and the price charged. Producer surplus is the area between the price charged and the supply curve. Keep in mind that prices and quantities cannot be negative. Hint: Area of a triangle = ½ b*h.] Now suppose the government decides the equilibrium price in this market is too high. It decides that price should not exceed $2 per unit. (An example of this is rent controls in New York City.) You can experiment with different price controls by moving the price slider up and down in the graph above. 3. Is this an example of a price floor or price ceiling? [A price floor (ceiling) is a limit on how low (high) a price can be charged for a product.] 4. What is the quantity demanded in this market? What is the quantity supplied? [Find where the horizontal price line intersects the demand and supply curves.] 5. Is there a shortage or a surplus in this market? How large is it? [There is a shortage if the quantity demanded is greater than the quantity supplied. There is a surplus if supply is greater than demand. Calculate the size by finding the difference between the two quantities.] 6. Calculate consumer surplus, producer surplus, and total surplus. [For one of these, you’ll add together the area of a triangle and a rectangle.] How do these values compare to when the market was equilibrium? 7. How large is the deadweight loss (DWL) shown in the graph by the red triangle? Now suppose that the government sets $1.50 as the maximum price. 8. What is different between the quantity demanded and quantity supplied? 9. What is the deadweight loss at this price? How does it compare to the $2 limit per unit? How does the total surplus change? 10. What do you conclude about the effect of price controls? Finally, suppose the government sets $4 as the maximum price. 11. How does this affect the market? [Hint: Firms do not have to charge $4 per unit. They just aren’t allowed to charge more than $4.] 12. What else do you conclude about price controls?