Question

Imagine the price of gasoline suddenly and unexpectedly rises. In response, the government passes a law mandating a maximum legal price for gasoline. You may assume the legal maximum price is below the current market price.

a. What do economists call these kinds of laws?

b. Using supply and demand analysis, show how the law affects the market for

gasoline. Label all important points.

c. The goal of this law was to make it easier for consumers to get gasoline. Has the

law achieved its desired purpose?

d. What other allocation scheme would you expect to arise, now that prices are not

the only mechanism for rationing gasoline? You may not include black markets or nepotism in your answer.

Answer 1

a) This is known as a price ceiling or price control measure . Such a control is imposed by the government to prevent the price of a good from rising to a very high level .

b) The graph is shown below . Price ceiling is only effective when placed below the equilibrium price level . The price is not allowed to rise beyond the ceiling causing shortage in the market . The quantity demanded is higher than supplied .

c) This law helps to keep the price of gasoline low and helps consumers to get gasoline at a lower price than free market price . But some consumers do not get gasoline because at this price ceiling the quantity supplied is lower and there is shortage in the market . So this law achieves its goal partially .

d) Now that there is shortage in the market and gasoline is an essential product so other means of distribution that might arise is rationing . Rationing is the controlled distribution of scarce resources, goods, or services, or an artificial restriction of demand . This is allocation by restricting quantity demanded by allocating a certain limit of gasoline per person or establishing a quota for purchase per head .