Overview
This lecture explains how price controls, such as price ceilings, create inefficiency in markets by reducing total economic surplus and introducing deadweight loss.
Price Controls and Market Equilibrium
- Economic surplus is the sum of consumer and producer surplus.
- In a free market, equilibrium occurs where supply equals demand (e.g., apartments at $1250).
- A price ceiling (e.g., $1000) sets a legal maximum price below equilibrium.
Effects on Consumer Surplus
- With a price ceiling, the price drops, increasing consumer surplus for those who secure apartments.
- Only 20,000 apartments are rented despite demand from 30,000 people, causing some consumers to miss out entirely.
- Overall, consumer surplus as a group increases, but some individuals are worse off.
Effects on Producer Surplus
- Producer surplus decreases because landlords receive a lower price ($1000 instead of $1250).
- Fewer apartments are rented (20,000 instead of 25,000), further reducing producer surplus.
Economic Surplus and Deadweight Loss
- Total economic surplus falls after imposing a price ceiling.
- Some surplus shifts from producers to consumers, but some is lost entirely, creating deadweight loss.
- Deadweight loss represents the reduction in market efficiency due to missed mutually beneficial trades.
Market Efficiency and Government Intervention
- In efficient markets, all mutually beneficial trades occur, maximizing welfare.
- Price controls prevent some beneficial trades, proving inefficiency.
- Government intervention can sometimes correct market failures (monopolies, pollution, public goods), but usually makes markets less efficient.
Key Terms & Definitions
- Economic Surplus — Total benefit to society, sum of consumer and producer surplus.
- Consumer Surplus — Difference between what consumers are willing to pay and what they actually pay.
- Producer Surplus — Difference between what producers receive and their minimum acceptable price.
- Price Ceiling — Legal maximum price set below equilibrium.
- Deadweight Loss — Loss of total surplus due to market inefficiency from interventions like price controls.
- Market Failure — Situations where free markets do not efficiently allocate resources (e.g., monopolies, externalities).
Action Items / Next Steps
- Review the graph illustrations of deadweight loss.
- Read the final slide for an alternative explanation of inefficiency.
- Prepare questions for module five.