What this lesson teaches
I can show how each intervention changes price, quantity, spending, revenue, consumer surplus and producer surplus.
Syllabus 9570, 2.1.3(b). Government Intervention in Markets: Government intervention in markets can affect the equilibrium price and quantity, consumer expenditure and producer revenue, consumer surplus and producer surplus
Make a guess
A maximum price cuts the price of a good and the quantity sold. Must consumer surplus rise?
- Yes. A lower price always raises consumer surplus.
- Not always. Fewer units are sold, so it can fall.
- No. Consumer surplus always falls under a price cap.
Show the answer
Not always. Fewer units are sold, so it can fall.
Buyers who get the good gain, but many lose out completely. If the shortage is large, or goods go to buyers who value them less, total consumer surplus can fall.
A binding price control cuts the quantity traded, so there is a deadweight loss.
With a maximum price, only Qs units are sold. Buyers who get them pay less, so they gain some of the producers' surplus. Producers lose.
But the units between Qs and Q0 are no longer traded. The value of those lost trades is a deadweight loss.
These diagrams assume the buyers who value the good most get it. If it is shared out by queue or ballot instead, consumer surplus is smaller, and the time spent queuing is a further cost.
A minimum price or a quota also cuts the quantity traded, so each creates a deadweight loss too.
- Maximum price
- Surplus moves to buyers; deadweight loss.
- Minimum price or quota
- Surplus moves to sellers; deadweight loss.
Worked example: A $4 cap, then an $8 floor
Without controls: 80 units at $6. Demand starts at $10 and supply at $2. Assume the buyers who value the good most get it.
- $4 cap: 40 units traded. CS = 1/2 x 40 x ($6 + $4) = $200. PS = 1/2 x 40 x $2 = $40.
- $8 floor: 40 units traded. CS = 1/2 x 40 x $2 = $40. PS = 1/2 x 40 x ($6 + $4) = $200.
- Either way, total surplus is $240, down from $320. The deadweight loss is $80.
- A cap shifts surplus to buyers; a floor shifts it to sellers.
Watch out for this
A maximum price always increases consumer surplus.
Buyers who get the good gain, but fewer units are sold. If the shortage is big, or the good goes to buyers who value it less, total consumer surplus can fall.
Check your understanding
A quota cuts the quantity traded from 80 to 40 units. Which statement is true?
- There is a deadweight loss from the 40 units no longer traded.
- Consumer surplus rises, because the 40 units left go to buyers who value them most.
- Total surplus is unchanged, because the higher price simply moves surplus to sellers.
Show the answer
There is a deadweight loss from the 40 units no longer traded.
Right. Those trades were worth more to buyers than they cost to produce, and that value is lost.