Temple University
Department of Economics

Economics 52

Price Ceilings and Economic Efficiency

Name Key

The Market for runcible spoons is characterized by the following pair of equations:

Q = - 100 + 10 P  Supply    P = 10 + 1/10 Q

Q = 200 - 5 P       Demand    P = 40 - 1/5 Q

1. In the boxes above indicate which is the supply curve and which is the demand curve.

2. What are the equilibrium price and quantity in the market for runcible spoons? Enter your answers in the boxes below.

Price =   Quantity =

-100+10P = 200-5P

P=20

Q=-100+10(20) = 100

3. What is the amount of consumer surplus in the market for runcible spoons?

CS = 1/2 (40-20)(100) = 1000

4. What is the amount of producer surplus in the market for runcible spoons?

PS = 1/2 (20-10)(100) = 500

5. What is the value of economic surplus? (This can be understood as the size of the economic pie that is shared by producers and consumers)

1000+500 = 1500

6. A price ceiling of P = 15 is imposed on the market for runcible spoons.  What will be the quantity demanded under the price ceiling?

Q = 200 - 5(15) = 125

7. With a price ceiling of P = 15 what will be the quantity supplied?

Q = -100 + 10(15) = 50

8. At the quantity supplied with the price ceiling of P = 15, what is the price that the marginal consumer would be willing to pay for a runcible spoon? Put another way, what is the reservation price for the 'last' customer purchasing a runcible spoon?  Reservation price =

P = 40 - 1/5 (50) = 30

9. What is the amount of producer surplus when there is a price ceiling of P = 15? Producer Surplus =

PS = 1/2 (15-10)(50) = 125

10. Has producer surplus increased, decreased, or remained the same? What is the amount of the change?

Producer surplus has declined from 500 to 125, an amount equal to -375.

11. What is the amount of consumer surplus when there is a price ceiling of P = 15? Consumer surplus =

CS = (30-15)(50) + 1/2 (40 - 30)(50) = 750 + 250 = 1000

12. Has consumer surplus increased, decreased, or remained the same? What is the amount of the change?

Consumer surplus has not changed.  Although there are fewer runcible spoons being traded, the difference between the price paid and the demand curve has increased for those still in the market.

13. What is the amount of total economic surplus when there is price ceiling of P = 15? Economic Surplus =

1000 + 125 = 1125

14. Has total economic surplus increased, decreased or remained the same? What is the amount of the change? The amount of this change is known as deadweight loss.

Total economic surplus has declined by 375.

15. Some consumers have been made worse off as a result of the imposition of the price price ceiling. True False  True.  Those who no longer able to buy are now worse off than they were before the imposition of the ceiling.

16. When comparing the free market result with the price ceiling result, the slice of the pie received by the marginal consumer has increased, decreased, or remained the same.

Under the free market the surplus accruing to the marginal consumer, that person whose reservation price is equal to the equilibrium price, is zero.  Under the price ceiling the reservation price of the marginal consumer is 30, but s/he only pays 15.

17. Producers have been made worse off as a result of the price ceiling. All, some, or none.  All producers are worse off.

18. In a complete reversal of policy the local government eliminates the price ceiling and instead imposes a price floor.  The price floor is set at P = 25.  When there is a price floor of P = 25 what is the amount of deadweight loss?

When there is a price ceiling of 25 the quantity demanded is 75.  At Q = 75 the reservation price of the marginal seller is 17.5.  The number of trades has declined from 100 to 75 units.  Therefore deadweight loss is DWL = 1/2 (25 - 17.5)(100 - 25) = 93.75

19. In comparison to the free market case in which there is neither a price ceiling nor a price floor, the effect of the price floor of P = 25 is make all, some, none of the original producers better off, worse off, or unchanged and all, some, none of the original consumers better off, worse off, or  unchanged?  The effect of the price floor is to make all consumers worse off.  Those sellers who now find that they have no consumers are made worse off.  But the sellers who have customers with the price floor are made better off.