Price Floor: Regulated price such that firms cannot charge below this price. A price floor will be
binding if it is set above the true equilibrium price. A binding price floor will lead to surplus because
the price is too high (Qs > Qd).
Qs ↑
Qd ↓
Surplus = Qs – Qd = 7 – 3 = 4
The quantity that is actually bought and sold will be determined by the amount that buyers are willing
to purchase at the regulated price.
Qd is bought & sold at Pf
P
10
S
Pf = 7
1
2
P* = 5
4
3
Prs = 3
D
3
Qd
5
Q*
7
Qs
10
Initial Equilibrium: consumers & producers buy & sell Q* = 5 units at P* = 5 per unit
With Binding Price Floor:
Qd = 3 units are purchased by consumers at Pf = 7 per unit
Consumers pay more per unit and buy fewer units
Area 1 = CS ↓ = (7 – 5) * 3 = 6 *transfer to sellers
Area 2 = CS ↓ = 1/2 * (5 – 3) * (7 – 5) = 2
Overall: CS ↓ = 6 + 2 = 8
Qs = 3 units are sold by farmers at Pf = 7 per unit
Producers sell fewer units at a higher price per unit
Area 1 = PS ↑ = (7 – 5) * 3 = 6 *transfer from buyers
Area 4 = PS ↓ = 1/2 * (5 – 3) * (5 – 3) = 2
Overall: PS ↑ = 6 – 2 = 4
*CS ↓ of 6 is just a transfer from consumers to producers.
This policy results in a net loss of 4 (DWL)
1
Q
Price Ceiling: Regulated price such that firms cannot charge above this price. A price floor will be
binding if it is set below the true equilibrium price. A binding price ceiling will lead to shortage
because the price is too low (Qd > Qs).
Qs ↓
Qd ↑
Surplus = Qd – Qs = 700 – 300 = 400
The quantity that is actually bought and sold will be determined by the amount that sellers are willing
to supply at the regulated price.
Qs is bought & sold at Pc
P
S
Prs = 700
1
2
P* = 500
4
3
Pc= 300
D
300
Qs
500
Q*
700
Qd
1000 Q
Initial Equilibrium: renters and landlords buy and sell Q* = 500 units at R* = 500 per unit
With Binding Price Ceiling:
Qs = 300 units are purchased by consumers at Pc = 300 per unit
Consumers pay less per unit but buy fewer units
Area 3 = CS ↑ = (500 – 300) * 300 = 60,000 *transfer from sellers
Area 2 = CS ↓ 1/2 * (700 – 500) * (500 – 300) = 20,000
Overall: CS ↑ = 40,000
Qs = 300 units are sold by producers at Pc = 300 per unit
Producers sell fewer units at a lower price per unit
Area 3 = PS ↓ = (500 – 300) * 300 = 60,000 *transfer to buyers
Area 4 = PS ↓ = 1/2 * (500 – 300)*(500 – 300) = 20,000
Overall: PS ↓ = 80,000
*PS ↓ of 60,000 is just a transfer from producers to consumers
This policy results in a net loss of 40,000 (DWL)
2