Question

Explain diagrammatically the various ways in which a price ceiling on gasoline that is set below the equilibrium price would make buyers and sellers of gasoline better off or worse off. What would happen to total surplus and deadweight loss in this market?

Answer 1

Price ceiling is type of price control implemented by the government or any other authority over the prices in a market, setting the selling price below current market price for goods and services. These efforts are taken in order to make the said commodity or service more affordable and to protect consumer interest from exploitation by the producers.

Let us see the Gasoline market conditions of equilibrium price and supply before price control:

Total Surplus = Consumer Surplus + Producer Surplus.

Equilibrium price and quantity are P and Q respectively.

Now, in the above case of the Gasoline market, there is a price ceiling set below equilibrium price ( Price Control). Let us see another diagram;

We see that the price ceiling initiative has set the price levels below the equilibrium price, at (P1). This makes producers in the gasoline market leave the industry, as prices are lesser to the point where earning higher profits is difficult. Now as prices are low , consumers demand gas more yet supply for gas has decreased. Therefore we see an instance of excess demand and shortage of supply in the market as quantity supplied of gasoline is lesser than the demand for it.

Also, consumer surplus increases as they pay even more less for the gas they purchase , thus inducing consumer surplus to rise. Yet producer surplus decreases as they are not able to sell at higher prices and prices are intentionally set lower by authorities, thus leading to a decrease in producer surplus.

The Total Surplus before the price ceiling is greater than the the Total Surplus after price ceiling and the difference between them is the dead weight loss created in the market.

Producers are worse off in the short run as their revenue is reduced, yet even though consumers enjoy lower prices in the short run, the excess demand and the shortage in supply in the market will induce the prices to go up.

In conclusion, as a result of a price ceiling in the gasoline market, the total surplus reduces along with increasing the dead weight loss in the market. Producers are worse off in the short run due to reduced prices and even though consumers enjoy low prices in the short run, the excess demand and shortage of supply in the market would induce the price levels to eventually rise.