Answer to Question #288515 in Microeconomics for uzair

Question

In 2021, a major ice storm hit the northern areas. The storm brought down power lines and trees, cutting electricity in many areas, making travel difficult, and slowing down repair crews. Heating homes became a major challenge. The storm created shortages of power generators. As a result, those products sold at prices much higher than normal. These high prices provoked cries of “price gouging” and calls on the government to impose price controls to prevent gouging. While no one likes to pay a higher price than normal for something, consider what would have happened with a price ceiling. The economic intuition is revealing.

Draw a diagram showing the market for generators with an equilibrium price at Rs.25,000. Now impose a price ceiling at Rs.20,000 per generator. What would be the impact of the price ceiling on the quantity demanded? On the quantity supplied? Who would benefit from the price ceiling and who would be harmed? Let the graph guide your thinking. Don’t start with your gut reaction!

Answer 1

People often expect government to solve problems that they seem unable to solve on their own. Sometimes this is effective and sometimes it is not. Price controls, either price ceilings or price floors, often have unanticipated side effects. Think about it: Passing a law doesn’t by itself make economic problems go away! Such is the case

with claims of price gouging, the charging of “excessively high” prices, which was exemplified by what occurred in the wake of an ice storm or other natural disasters.

Imposing a price ceiling below the equilibrium price may create as many problems as it solves. The basic problem is that the demand for power generators is dramatically

higher, since the supply of electricity was compromised. At the same time, the supply of generators was less as a result of storm damage and the inability to travel. The question

is how to deal with the shortage, that is, how to allocate the limited supply of generators among competing needs and wants. When a price ceiling reduces the legal price of a

product, businesses have less incentive to supply the product. Economically speaking, the law of supply says that at lower prices, the quantity supplied will be lower. At the

same time, the law of demand states that at a lower price, the quantity demanded will be higher. This can be seen clearly in the graph. So who gets the limited supply? As Shakespeare said, that is the question. Unfortunately, there is no clear answer to this. It could be first come, first serve. It could be friends of the seller. In many cases, what results are under-the-table payments by consumers willing to violate the law. What is

certain is that fewer generators get to consumers than would be the case if the price were allowed to rise. Many would argue that this shortfall is not the best outcome.