Question

Only provide your opinions when specifically called for. In all other cases your answer(s) should rely on the text and module materials and not on the internet, showing your capacity to apply the appropriate economic principles and concepts correctly.

In 2014, a major ice storm hit the southeastern U.S.. The storm brought down power lines and trees, cutting electricity in many areas, making travel difficult, and slowing down repair crews. Heating homes became a major challenge. The storm created shortages of power generators. As a result, those products sold at prices much higher than normal. These high prices provoked cries of “price gouging” and calls on the government to impose price controls to prevent gouging. While no one likes to pay a higher price than normal for something, consider what would have happened with a price ceiling. The economic intuition is revealing. Draw a diagram showing the market for generators with an equilibrium price at $250. Now impose a price ceiling at $200 per generator. What would be the impact of the price ceiling on the quantity demanded? On the quantity supplied? Who would benefit from the price ceiling and who would be harmed? Let the graph guide your thinking. Don’t start with your gut reaction! Did the price ceiling help the people it was designed to help? Explain the economic reasoning behind your analysis.

Answer 1

In following graph, Price and quantity are measured vertically and horizontally respectively. D0 & S0 are demand & supply curves intersecting at point A with equilibrium price P0 (= $250) and quantity Q0.

After the ceiling price is imposed at Pc (= $200), quantity demanded will rise to Qd, since ceiling price is less than market equilibrium price. Quantity supplied will fall to Qs at lower price, following law of supply. Therefore, there will be a shortage equal to (Qd - Qs). All intended beneficiaries will not be able to buy at the lower ceiling price. Therefore, consumers who will be able to buy at Pc, will gain. Producers will lose (since price will fall), and the consumers who are willing to pay $200 but unable to buy due to shortage will lose as well.