Question

Price controls create two forms of inefficiency. Describe them and illustrate them using the supply and demand model.

Answer 1

Price controls are government-mandated minimum or maximum prices set for specific goods and are typically put in place to manage the affordability of the goods.

The two inefficiencies created by price control are :

• Increasing dead-weight loss - Due to price ceiling an inefficient outcome occurs and the total surplus of society is reduced. The loss in social surplus that occurs when the economy produces at an inefficient quantity is called deadweight loss. In a very real sense, it is like money thrown away that benefits no one. In Figure the shaded portion shows the dead weight loss. When deadweight loss exists, it is possible for both consumer and producer surplus to be higher, in this case because the price control is blocking some suppliers and demanders from transactions they would both be willing to make.
• Reduction in overall social surplus - A second change from the price ceiling is that some of the producer surplus is transferred to consumers. But the gain to consumers is less than the loss to producers, which is just another way of seeing the deadweight loss, and hence there is overall loss of surplus to society.

It can be seen graphically as -