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Market Distortions

Altering the Supply and Demand Equilibrium

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Market distortions by governments can come in many varieties, such as taxes and competition law. However, we will concern ourselves with the two most basic forms of market distortions, which are as follows:
  • Price Restrictions
  • Quantity Restrictions

Market Distortions - Price Restrictions

There are two types of price restrictions we see in government policy:
  • A price ceiling - A maximum price that can be charged by a company for a product or service.
  • A price floor - A minimum price that can be charged by a company for a product or service.
In order to make the discussion interesting, we will only consider case where the restriction has some 'bite'. A restriction making it illegal to charge more than 1 million dollars for a cup of coffee is not a particularly interesting scenario to analyze.

Price Ceilings - Maximum Prices

Two of the most common types of price ceilings are as follows:
  • Rent Control
  • Oil in the 1970s
Consider the following Demand and Supply schedules for oil:

Demand

90 cents - 125M gallons
80 cents - 127M gallons
70 cents - 129M gallons
60 cents - 131M gallons
50 cents - 133M gallons

Supply

90 cents - 150M gallons
80 cents - 142M gallons
70 cents - 129M gallons
60 cents - 121M gallons
50 cents - 108M gallons


Without any price controls put into place, thr equilibrium price would be 70 cents and 129M gallons would be sold.

Now suppose the government places a maximum price of 60 cents on oil.

At this price, we have a quantity demanded of 131M gallons but a quantity supplied of only 121M gallons - a shortage of 10M gallons. In the 1970s this manifested itself with gas stations 'running out' of gasoline and long lines to buy gas from the stations with remaining stations.

Minimum Price Perspective

These are most commonly encountered as minimum wages for low skilled labor.

To keep the analysis simple, we will use a similar example to the one above. What if, instead the government had set a minimum price of 80 cents a gallon. In that case the quantity supplied of gas is 142M gallons and the quantity demanded is 127M - a surplus of 15M gallons. There would be more gas available on the market than consumers would want to buy. In the minimum wage case, it would mean there are more individuals looking for minimum wage jobs than there are jobs available.

Next article: Quantity restrictions.

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