Question

Suppose that OPEC cartel imposes an embargo on oil exports to the US, which causes global oil prices to double that forces the domestic gas prices to rise to $5 per gallon. Thus, to make gasoline more affordable for American consumers the US Government decides to impose $3 price ceiling on it at the retail level. What would be the economic consequences of such government intervention in the market mechanism? What alternative rationing mechanisms will the market have to resort to as the means of gas distribution if the price ceiling remains for a long time?

Answer 1

A price ceiling is mandating the maximum price that the producer can charge for a good. The price ceiling one of the many tools that the government use to control the free market mechanism of any goods.

In this case, the price ceiling is set below the market clearing rate of $5. That is at the sealed price of $3 there will be more potential buyers than sellers. That is there will be excess demand in the market.

As the current price does not clear the market (demand equals supply), the market resort to other non-price mechanisms. For example, the excess demand will cause long waiting lines at the gas station. People have to wait to get gas as supply is below demand at a market price of $3. The time cost will increase the price of gas near the equilibrium price. If the price control lasts in the long run, there will be an illegal market for gas, where the gas will be sold at a market price outside the legal market for gas.