Reflection – Price Ceilings and Price Control

1) I found the Problem Based Learning (PBL) was very effective in reinforcing the ideas presented in lesson 2.1. While it allowed us to apply our knowledge to real-world type situations, we were also limited in the way we were allowed to express our understanding. We can apply all of the economic terms we understand to solving the problem, but in presenting our findings to a rather uneducated audience we were left with a more or less ‘dumbed-down’ version of our final conclusion and opinion. The inclusion of an Op-Ed piece was also very useful, as we were required to persuade an audience now instead of simply informing, something that real economists must be able to do effectively if they are to convey an idea to large audiences. While this let us practice restricting our vocabulary and conveying our ideas through simpler means, it also meant cutting out a large part of our findings and explanation behind our thinking, which I found to be a very core and integral part of the project.

2) The most important thing we’ve learned so far in this lesson is about how price control can create shortages or surpluses. This is crucial in understanding both why price controls restrict free market equilibrium and can impact the efficiency of the market. Without price controls, the market can operate at a price that guarantees a maximum surplus for both producers and consumers, making the population of both groups much happier. In times of shortages or inflation however, price control could in fact help the economy by limiting the amount of a resource consumed over a certain period of time, or allowing everyone to be able to afford that resource to survive.


Why Price Ceilings Create Shortages

In this post I’ll be describing how prices ceilings create shortages in an economy. First off, a price ceiling is the maximum highest price a resource can sell for in an economy. This means that the product cannot be sold, or bought for higher than this price. It is common to see price ceilings on very scarce resources to keep their prices from rising as demand increases. A good example is gas. The price of gasoline in the United States has risen to extreme values in the last ten years. Imposing a price ceiling on gasoline would ensure that price is kept affordable for everyone, however, it also creates shortages as the supply for gasoline and the demand for gasoline are not equal. This can be shown in a supply and demand curve diagram.

Logic would dictate that the price for gasoline in this economy would be equal to the point at E1, where both supply and demand are equal. At this point producers are supplying the gasoline they want to at a price they can justify, and consumers are demanding that exact mount of gasoline for the same price that producers are selling it for. This point, located at E1, is known as equilibrium, or the point at which both the supply and demand curve are satisfied. If a price ceiling is imposed though, the maximum price a product can sell for is shifted down to Pc. At this point, the amount supplied along the supply curve is only S1, and the amount demanded is D1. As we can see from tracing the points down to the quantity axis, supply is much less than demand now, given that the gasoline’s selling price is restricted by the price ceiling. If supply is less than demand, that the gasoline will face a shortage, since both supply and demand fall below the point of equilibrium. With demand now overpowering the supply, not everyone will receive gasoline. This shortage is represented on the diagram as the line below the point of equilibrium.

A black market is a market that sells goods or resources without the restrictions placed on them by regular pricing; in this case a price ceiling. A black market would alleviate the shortages created by imposing the price ceiling by allowing people who desperately need gas, but are supplied none due to shortages, to buy the resource for a price not regulated by the price ceiling. This price would most likely be very high, much higher than the gas produced under the price ceiling, but it would also create a supply for a resource to a population that would not be able to afford the gas at all due to shortages, helping alleviate shortages.

The Invisible Hand: Blog Post #1

In this scenario, we as a policy group know that there are shortages for gasoline in the economy, as supply is failing to keep up with demand. We also know that in order to counter rising gas prices we must create a price ceiling for gasoline that allows different priorities of people to receive the necessary amounts of gasoline needed. That is, high priority groups receive all of the gasoline they need, the medium priority group receive most of the gasoline they need and the low priority groups receive whatever gas remains from the frist two groups. We also know that we have a time restriction until the secretary of the DoE, Les Singer returns from his trip. What we do not know is exactly where we have to set the ceiling, who falls in what priority groups, and how big of a shortage we are suffering due to the increasing demand for gasoline.

Our problem statement is, How can we, as the policy group to the secretary of the Department of Energy set an appropriate price ceiling, so that each priority group can receive the amount of gasoline they require.

Another problem we must address is, How can we understand that price ceilings prevent the laws of supply and demand from operating, and express that via both diagrams and plain English.

Russia Considering Price Ceiling on Food

This Businessweek article describes how Russia may have to set a price ceiling on food in coming weeks due to severe droughts in the country. Russia is predicted to lose almost 30 million metric tons of it’s grain crop as a result of a series of droughts that have plagued the country’s already suffering economy. The loss of crops is expected to increase upon the already severe rise of inflation in the country as market prices soar. Consumer prices in the country have risen by 0.6% in the last month, no doubt aided by the droughts. The overall prediction for price rise in 2010 for the Russian market is set at 7.6%. However, Russian agriculture minister Yelena Skrynnik seemed hopeful, saying that Russia was prepared for the drought, and has sufficient grain reserves to get through the rough time. The implication of a price ceiling however could also help fend off the growing inflation in the country, as represented on a supply and demand curve diagram.

As can be seen below, the recent droughts in Russia have caused a severe drop in the country’s grain supply capability. This drop in supply is represented by a shift from S1 to S2. S1 represents the country’s supply of grain before the drought, while D1 represents Russia’s demand for grain. As we can see, the supply and demand for grain in Russia is equal prior to the droughts. This is represented by the fact that Q1, the quantity of grain being supplied, is located along in the intersection of both S1 and D1. This is called equilibrium, or the point at which both the supply and demand are satisfied.

However, due to the major droughts in Russia, the maximum quantity of grain the economy is able to supply decreases. This decrease is represented by a shift from S1 to S2. As we can see, this affects the quantity supplied as well, as there is a shift from Q1 to Q2 along the supply axis. Throughout the shift the price is initially maintained at P1. Q2 however represents a point along the supply curve that does not create equilibrium as it does not fall along the D1 line as well. Instead the new quantity falls below the demand curve, resulting in a shortage. A shortage is when the quantity of an item supplied is less than the quantity that the item is demanded. On a diagram this is represented by having a point falling below the point of equilibrium. Naturally however, the market is trying to find equilibrium in order to satisfy the needs of both the consumers and producers. In this situation, it can be expected that the price of grain will rise in order to create a movement along the supply curve to meet the demand of the market. However, the Russian government fears this will add to the severe inflation in the country and are therefore considering imposing a price ceiling, or the maximum price a product can be sold for, in this case grain. This is represented on the diagram below.

Q2 from the first diagram falls below its point of equilibrium. Assuming the market is functioning normally the price of grain will increase until it reaches this equilibrium, represented at point E1. However, the Russian government could impose a price ceiling, limiting how much price could sell for in the market. This price ceiling is represented by point Pc along the Price axis. Imposing a price ceiling would help keep grain affordable in the market for all classes, especially the poor farming class, who are expected to take the biggest hit from the droughts. The price ceiling also creates a shortage of grain in the country, as the quantity supplied falls below equilibrium. Responding to this, the Russian government is using it’s grain reserves to help boost the economy’s supply of grain temporarily and keep grain affordable and available for everyone.