Hi, welcome back. In this video, we're going to discuss price ceilings and the  misallocation of resources. Here, we just want to talk about a simple illustration  of price controls, right? With higher demand, right? But with a price control, right, such as a price ceiling, right, you cannot go above a certain price, no matter  what the demand is. So the government can set a price, right, and they can say  this is the ceiling, and no company can charge more than this price, right. So it's  a ceiling, it's a top. We can't go above this price, no matter the demand. So this  can lead to misallocation of resources, right? Because they can all they can see  that demand be equal because prices are capped, right? So then the the  resources may get misallocated to not going to the higher demand areas, right?  So you can see how this flows out, right? Like in sunny California, they're  pumping oil. They have the oil. They're flowing it to the snowy Northwest, and  you know they may not get all of the oil that they need because there is no  demand control mechanism, right? There's no way to actually allocate the  resources because there is no demand mechanism, right? Because the price is  capped, right? So we don't see the sliding scale like we would in other  opportunities. So this leads to distorted price signals cause resources to be  misallocated, right? So let's look at this graph, okay? So so so price control  prevents the highest valued uses from outbidding lower valued uses, right? So  you can't bid up the price if there's a price ceiling, right? So so if so, if I'm in New York and it's snowing and I need oil to heat my home and and fuel my car and  I'm willing to pay $4 because we need more of it, right? The government says  no, it's a $1 price ceiling. So now we're going to distribute it evenly, and demand  doesn't matter anymore because no matter how much you need it, we're going  to charge you the same price, even if you're willing to pay more, right? So this  leads to misallocation of resources. More demand needs to go up in the  northwest or the northeast, but we're sending it to the southwest because it  doesn't matter. It'll be cheaper transportation costs for us, and we don't have to  worry about shipping it to New York, and we can make more money that way  with the controlled price ceiling, right? So it doesn't necessarily go to the highest value uses, which which is a consumer protection mechanism, right? Because in this case, oil is a much needed resource, right? And it's a it's a limited amount,  so so governments may come in and set a price ceiling in order to protect their  consumers. Because if it was a toll free market and the price was you know it's  it's really really cold up in New York, and and we need a ton of fuel, right? We  may, you know, we may bid up the competition just to make sure that we receive the right amount of of resources, right? But but but that with the price ceiling,  that doesn't necessarily happen, right? It doesn't happen because there's no  there's nothing that attributes to demand. So if you look at the graph, okay, you  can see the demand curve downward sloping supply curve, upward sloping.  Right. So so we're we're meeting here at equilibrium somewhere around $2.  Okay, but because there is a price ceiling, right, the quantity supplied is going to 

be limited, right? We're not going to be at at equilibrium production because the  price is too low, right? So, so, so, but because the price is so low, the demand is very, very, very high, right? So, so, so, so in this instance, the price ceiling is  really hurting the consumer, right? Because we're not producing enough of the  resource in this case, gasoline, right, to meet the demand in the market, right.  So therefore, therefore, it leads us to create a shortage in supply, right. And  even though there's a shortage in supply, the price doesn't go up; it stays the  same, right? But there are less producers willing to produce gasoline at $1 than  there would be, obviously, at $4. Because if you notice that the supply curve is  way out in the future, right? At at. $4, right? So we're willing. So companies are  willing to produce a lot of gasoline at $4, but demand at $4 is here. So so so  then we'd be oversupplied, right? So but here because the price ceiling, right?  We are running at a deficit or a shortage. So now resources are misallocated  because of the price ceiling, right? So we're not, you know, we're not allocating  out to the to the best uses of our resources, right? So the least valued uses not  willing to pay even controlled price, right? So so down here is what I'm talking  about, right? So, so if we can, so the least valued use is not even willing to pay  the control price, right? There's no one wanting to pay for it down there, right?  So, what's maximum consumer surplus with the quantity supplied, right? So, so  if the gasoline goes to the highest valued users, consumer surplus is given by  the green area. So let's say all of the gasoline went to New York, right? And they had a $4 value on this gasoline because they needed it so much. But the price  ceiling is at $1, right? So the consumer surplus, right? It's not necessarily a  monetary figure, but it's a utility figure. It's the benefit. It's the marginal benefit,  the marginal utility that they're going to get or that they're going to receive from  buying the gasoline at $1 because they value it at $4, right? So, so we're paying  the $1 price. I value it at $4, so therefore I have this $3 marginal benefit that I  receive in a consumer surplus, right? So, so that's so that's good if we can  receive the gasoline that we need if we're up in the Northeast, right? So, so we  here is a graphical indication of consumer Surplus. So, so let's talk about the  loss from random allocation, right? Because goods are not always allocated to  the highest value uses, consumer surpluses will be less, right? Well, how much  less? Let's do some reasonable calculations, right? First, we will consider how  one gallon of gasoline might be allocated under the best and worst conditions  for random allocation. So let's take a look, right? The loss from random  allocation of one gallon. This is best case scenario, right? So we still have the $1 price ceiling. We still have demanders at $4, right? Well, the best case scenario, the buyer with the very highest value use gets the gallon of gas, right? So the  value is created at $4. Well, we see that the consumer surplus again is $3, but  they're only able to get one gallon. It's random allocation, right? Because there's no demand driver. Demand does not mean anything because the price is  controlled, so demand can be equal and all else equal, right? Because of the $1 

price ceiling, right? So I'm not going to sell it to the highest bidder because I  can't, right? So if I'm able to get this one gallon of gas, right, and I receive it at  $1, and I'm willing to pay $4, now I've created a $3 consumer surplus again, but  I'm only able to get limited quantities. In this case, one gallon. Now, the worst case scenario from random allocation, right? The buyer with the lowest valued  use, but still willing to pay controlled price, gets the gallon of gas, right? So, so,  so the buyer with the lowest valued use, right? We're talking about this area,  right? So here, so they they are the the lowest valued use, right? Let's say they  value the gasoline at 10 cents, right? But they're getting the the you know the  the price that they're having to spend $1, right? So there is no consumer surplus then, right? Because they're paying more than they want, but they have to have  the price at $1, right? So so they create a $1 in value, but the consumer surplus  is zero. All right, so so this is the equal probability scenario, right? Each gallon is allocated with equal probability to any buyer whose value is between $4 and $1.  On average, buyers will value the gasoline at $2.50, right? On an equilibrium  basis, so so so we'll see 0.5 times 4 plus 0.5 times 1. Right, because this is  we're trying to get the average value. Right, so we're we're getting the average  value. So so our scenario. So now we'll have this is our under random  allocation. This the green block here, the green square represents on an  average value basis our consumer surplus, right? Which is $1.50, which is still  fine, right? We we get our gasoline. The average value is $2.50. So, but our  consumer surplus has kind of decreased a little bit because we're looking at it on average basis. So, so you see the red you see the the red shape here loss due  to random allocation compared to what it would be if it was maximized, right?  So, so now it's it's because it's randomly allocated and and we're just distributing gasoline however we see fit. There's no coordination in our allocation, so now  we are not going to be able to grab that consumer surplus, right? That added  marginal utility or benefit because it's at a random allocation, right? So, but this  is and a random allocation. This is probably the best scenario possible, right?  Because we are getting the allocation, and and and it's got probably a little  more, you know, you know, coordination to it, right? It's got a little more  coordination to it in this scenario. So, price ceiling - a maximum price allowed by law, right? Rent control, let's say kilowatts in your electric things like that, right?  Anything that the government can put a price ceiling on to control prices to  protect consumers, right? So, so five important effects of a price ceiling. One is  we pointed out in previous slide, a shortage, right? He created a shortage.  There's so much demand that there's not enough supply. Therefore, demand  doesn't matter, and allocation is random. So, so how the resources are allocated is is purely on randomness, right? So reductions in product quality because we  can only get $1 of value. We're not going to spend a lot of money to make it a  high quality product because we're getting very minimal return on that  investment. Wasteful lines and other search costs, right? So we're just we're 

we're wasting cash doing research and development for products that can only  that have no growth opportunity, right? A loss in gains from trade. This can  create a dead weight loss, right? And and obviously a misallocation of  resources. 



Last modified: Wednesday, September 2, 2026, 8:34 AM