How do price controls distort incentives?

1 Answer
Sep 14, 2015

Price controls distort market equilibria.


Here is a set of graphs I have drawn to help the explanation.

For price ceilings (the graph on the left) we can see that a maximum price results in a shortage of the good. At P(max), we can see that producers only want to provide Q(supply), while consumers want to buy Q(demand), which is much greater. At P(max), producers do not have an incentive to provide more than Q(supply).

For price floors (the graph on the right), we can see that a minimum price results in a surplus of the good. At P(min), we can see that consumers only want to buy Q(demand), while producers want to sell Q(supply), which is much greater. At P(min), consumers do not have an incentive to purchase more than Q(demand).

In both graphs, we can see that the market equilibrium price, P(e), is the only price that gives producers and consumers the incentives that actually balance the quantity supplied with the quantity demanded, labeled Q(e) in both graphs.