1. What is meant by deadweight loss? Why does a price ceiling usually result in a deadweight loss?
2. Suppose the supply curve for a good is completely inelastic. If the government imposed a price ceiling below the market-clearing level, would a deadweight loss result? Explain.
3. How can a price ceiling make consumers better off? Under what conditions might it make them worse off?
1) Deadweight loss refers to the benefits lost by consumers and/or producers when markets do not operate efficiently. The term deadweight denotes that these are benefits unavailable to any party. A price ceiling set below the equilibrium price in a perfectly competitive market will result in a deadweight loss because it reduces the quantity supplied by producers. Both producers and consumers lose surplus because less of the good is produced and consumed. The reduced (ceiling) price benefits consumers but hurts producers, so there is a transfer from one group to the other. The real culprit, then, and the primary source of the deadweight loss, is the reduction in the amount of the good in the market. 2) When the supply curve is completely inelastic, it is vertical. In this case there is no deadweight loss because there is no reduction in the amount of the good produced. The imposition of the price ceiling transfers all lost producer surplus to consumers. Consumer surplus increases by the difference between the market-clearing price and the price ceiling times the market-clearing quantity. Consumers…
capture all decreases in total revenue, and no deadweight loss occurs. 3) If the supply curve is highly inelastic a price ceiling will usually increase consumer surplus because the quantity available will not decline much, but consumers get to purchase the product at a reduced price. If the demand curve is inelastic, on the other hand, price controls may result in a net loss of consumer surplus because consumers who value the good highly are unable to purchase as much as they would like. The loss of consumer surplus is greater than the transfer of producer surplus to consumers. So consumers are made better off when demand is relatively elastic and supply is relatively inelastic, and they are made worse off when the opposite is true.