Question

The market for face masks in China is in equilibrium (initial equilibrium price is P 1 ∗ and initial equilibrium quantity is Q 1 ∗).

Suppose the Chinese government imposes a binding price ceiling in the market.  

• First, please draw demand and supply curves such that consumers collectively are better off after the price ceiling is imposed. Please talk about the the winners and losers from this government intervention here/in this case.
• Second, is society as a whole better off ? If no, identify and shade the area of DWL on your graph. Intuitively explain your answer (in layman's terminology)
• Lastly, if demand for face-masks increased after the government intervention, say due to more buyers wanting the product because we got hit by COVID-19, will DWL increase or decrease? Also, will shortage of masks increase or decrease?

Answer 1

In the initial equilibrium, S=D, Price = P1 and quantity = Q1

After the binding price ceiling PC, Equilibrium quantity = QSX and the welfare of the buyers increases by the area C while losing area B

The producers loses area C+D

The deadweight loss from the price ceiling = area B+D

The society as a whole is worse off as the equilibrium quantity traded is now lower and there is deadweight loss

When the demand increases, the DWL would increase in the long run as there would be a shortage of the masks because the producers will supply less at the price ceiling.