AP, IB, and College Microeconomic and Macroeconomic Principles 

How do price controls impact markets? AP/IB/College

How do price controls impact markets?

Updated 5/1/2018 Jacob Reed
Below is a review of  how price controls prevent a market from reaching equilibrium and create dead weight loss. If you would like to get some practice with these concepts, head over to the microeconomics important points, prices, and quantities game or the microeconomics graph shading practice.

Allocatively Efficient Market

When a market is at equilibrium, it is allocatively efficient; there is no dead weight loss and economic surplus (consumer surplus + producer surplus) is maximized.

Sometimes the government may impose price controls on a product to help alleviate a social problem; like prevent price gouging with price ceilings or help farmers with price floors. But there will be a loss of market efficiency and dead weight loss will replace some economic surplus.

How does a price ceiling impact a competitive market?

A price ceiling is a maximum price set by the government that can be charged for a product. If the government imposes an effective price ceiling (one that is below the market equilibrium price) the market cannot reach equilibrium.  At the artificially low price, the quantity supplied will be less than the quantity demanded. The difference between the two is a shortage. The Quantity supplied is all that gets sold with a price ceiling. Since price cannot rise, the shortage will remain. This will create dead weight loss and the market will no longer be allocatively efficient. 

Price Ceiling Graph Shaded

*Note: if a price ceiling is placed above equilibrium, it is not effective (or binding) so the market price will move toward equilibrium, and there will be no dead weight loss. 

How does a price floor impact a competitive market?

​A price floor is a minimum price set by the government that can be charged for a product. If the government imposes an effective price floor (one that is above the market equilibrium price) the market cannot reach equilibrium. At the artificially high price, the quantity demanded will be less than the quantity supplied. The difference between the two is a surplus. The quantity demanded is all that gets sold with a price floor. Since price cannot fall, so the surplus will remain. This will create dead weight loss and the market will no longer be allocatively efficient. 

Price Floor Graph Shaded

*Note: if a price floor is placed below equilibrium, it is not effective (or binding) so the market price will move toward equilibrium, and there will be no dead weight loss. 

Multiple Choice Connections:
2012 Released AP Microeconomics Exam Questions: 4, 17

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