The Effect of the Price on the Deadweight Loss - Article Example

Price ceiling The effect of the price ceiling on consumers, producers and the deadweight loss According to Landsburg (242), price ceiling is a maximum price that a given product or service is allowed to sell. The effect of price ceiling is determined by its level. Where the equilibrium price is below the mandated legal maximum price, the price ceiling poses no effect at all. For price ceiling to be effective, it has to be set below the equilibrium price. The figure 1 below shows that the rent of the house is P.

Qs is the number of houses property developers are willing to rent out and Qd is the number of houses consumers are willing to rent. The actual houses rented are Q s because the owners close other houses when Qs are sold. Some consumers may wish to rent houses at higher rates than P and sellers may violate the existing law by accepting these prices offered. Therefore, sellers may accept price E because the consumers will be willing to rent rates above P as competition arises among consumers who strive to acquire the scarce commodity.

The prices will go high up to E which is illustrated in the diagram below. The quantity demanded exceeds Qs at any lower price than E, and consumer’s effort remains intensified. The market reaches the Equilibrium only when the price reaches P. The competitive price is D. The price the suppliers will receive is P regardless of the higher price due to price ceilings. Hence, price E is used in calculating the consumer’s surplus. Producer’s surplus is calculated using P. In both cases, the actual quantity of houses is Qs.

According to Taylor and Weerapana (194), when the government imposes price ceiling, producers will sell less quantity at lower prices and will lose some profits. If some consumers purchase products at higher prices, producers will gain. However, other consumers will lose because the supplies will be scarce. According to Hirschey (437), dead weight loss results from competitive market equilibrium deviations. He further asserts that deadweight loss can occur to both consumers and producers and is not transferable.

Instead, losses arise from imperfections in the market and government policies. Deadweight loss is known as welfare loss triangle. This is because when linear curves of supply and demand are used, deadweight losses are portrayed as triangles. Figure 1- The diagram illustrating consumer and producers surpluses and losses as well as dead weight loss. From the figure above, the effects of imposition of price ceiling on both the consumer and producer surplus is shown. The sum of consumer and producer surplus before the price ceiling was imposed is shown by the area of triangle ABC, the area BCD shows consumer surplus and the producer surplus is illustrated by the area ACD.

The impact of price ceiling on consumer surplus is ambiguous. First, more consumer surplus will be obtained by consumers who are in position to purchase the commodity at lower price. However, consumer surplus will be lost by those who had the ability to purchase the commodity initially but now cannot. This results from availability of smaller quantity of goods to be purchased. The area BFGP, illustrates consumer surplus, which portrays increase in DPGI and decrease of CFI up from the previous consumer surplus level.

However, producer surplus is unambiguously reduced by CDPG amount. The outcome (lost consumer surplus plus lost producer surplus) is a deadweight loss illustrated in the area CFG. References Hirschey, M. Fundamentals of Managerial Economics. USA: Cengage Learning, 2009. Landsburg, S. Price theory and applications. USA: Cengage Learning, 2008. Taylor and Weerapana. Principles of Microeconomics. USA: Cengage Learning, 2007.