Analysis of Competitive Markets Lecture: Price Ceilings

Welfare effects of a price ceiling

When government institutes a price ceiling, the price of a good cannot go above that
price. With a binding price ceiling, the well-being of producers and consumers are
affected. How much they are affected can be determined by measuring changes in
consumer and producer surplus. When price is held below equilibrium, the quantity
demanded ________ and quantity supplied _______ (relative to equilibrium).

Consumers
Some consumers are better off because of the price ceiling. Why?

Some consumers are worse off because of the price ceiling. Why?

What happens, then, to the welfare of consumers as a group?

Producers
The price ceiling causes some producers to exit the market, while other producers remain
in the market and sell less at a lower price. In both cases, producers are harmed by the
price ceiling.

Ceiling

Change in consumer surplus due to this price ceiling?

Change in producer surplus due to this price ceiling?

Change in total surplus due to this price ceiling?

Elasticity of Demand and Welfare Changes

Consider the effects of a price ceiling on consumer welfare under two possibilities:
elastic demand and inelastic demand. We show these effects below:

Ceiling

Ceiling

Q
 Example: Price controls on Natural Gas
As the prices of oil and natural gas have risen in recent years, some groups have argued
for price controls. In this example, we calculate the impact of a binding price ceiling on
the natural gas market, based on market conditions in 2007.

First, the equations and data:

QS = 15.90 + 0.72PG + 0.05PO (Quantity supplied in trillion cubic feet (Tcf))
QD = 0.02 – 1.8PG + 0.69PO (Quantity demanded (Tcf))
(Where PG = price of natural gas in $/mcf, and PO = price of oil in $/barrel)

Using PO = $50/barrel gives equilibrium values for natural gas.

 Equilibrium price is ______ per mcf
 Equilibrium quantity is ________ Tcf

Suppose that a price ceiling is set at $3/mcf. Does anyone else smell a shortage of natural
gas?

EVALUATING THE GAINS AND LOSSES FROM GOVERNMENT

9.1 POLICIES—CONSUMER AND PRODUCER SURPLUS

Supply: QS = 15.90 + 0.72PG + 0.05PO

Figure 9.4 Demand: QD = 0.02 − 0.18PG + 0.69PO
Effects of Natural Gas Price
Chapter 9: The Analysis of Competitive Markets

Controls
The market-clearing price
of natural gas is $6.40
per mcf, and the
(hypothetical) maximum
allowable price is $3.00.
A shortage of 29.1 − 20.6
= 8.5 Tcf results.
The gain to consumers is
rectangle A minus
triangle B,
and the loss to producers
is rectangle A plus
triangle C.
The deadweight loss is
the sum of triangles B
plus C.

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 The Market for Human Kidneys
The 1984 National Organ Transplantation Act prohibits the sale of organs for transplantation
What has been the impact of the Act?

9.2 THE EFFICIENCY OF A COMPETITIVE MARKET

Figure 9.6
The Market for Kidneys and the Supply: QS = 16,000 + 0.4P
Effect of the National Organ
Transplantation Act Demand: QD = 32,0000.4P
Chapter 9: The Analysis of Competitive Markets

The market-clearing price is

$20,000; at this price, about
24,000 kidneys per year would
be supplied.
The law effectively makes the
price zero. About 16,000
kidneys per year are still
donated; this constrained
supply is shown as S’.
The loss to suppliers is given
by rectangle A and triangle C.
If consumers received kidneys
at no cost, their gain would be
given by rectangle A less
triangle B.

Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall • Microeconomics • Pindyck/Rubinfeld, 7e. 10 of 28
WELFARE ANALYSIS
Suppliers:
 Those who supply them are not paid the market price, estimated at $20,000

 Some who would donate for the equilibrium price do not donate in the current market

Potential Recipients:
 For those who get kidneys, they do not have to pay for them.

 Those who cannot obtain a kidney lose surplus

Dead Weight Loss of:

Other Inefficiency Costs:

Arguments in favor of prohibiting the sale of organs: