Chapter 15 APPLIED COMPETITIVE ANALYSIS MICROECONOMIC THEORY BASIC PRINCIPLES AND EXTENSIONS EIGHTH EDITION WALTER NICHOLSON Copyright ©2002 by South-Western, a division of Thomson Learning.

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Chapter 15
APPLIED COMPETITIVE
ANALYSIS
MICROECONOMIC THEORY
BASIC PRINCIPLES AND EXTENSIONS
EIGHTH EDITION
WALTER NICHOLSON
Copyright ©2002 by South-Western, a division of Thomson Learning. All rights reserved.
Price Controls
• Sometimes the government may seek
to control prices at below equilibrium
levels
– will lead to a shortage
• We can look at the changes in producer
and consumer surplus from this policy
to analyze its impact on welfare
Price Controls
Price
Initially, the market is
in long-run equilibrium
at P1, Q1
SS
LS
P1
Demand increases to D’
D’
D
Q1
Quantity
Price Controls
Price
SS
In the short run, price
rises to P2
P2
LS
P3
Firms would begin to
enter the industry
P1
D’
The price would end
up at P3
D
Q1
Quantity
Price Controls
Price
Suppose that the
government imposes
a price ceiling at P1
SS
LS
P3
P1
D’
There will be a
shortage equal to
Q2 - Q1
D
Q1
Q2
Quantity
Price Controls
Price
Some buyers will gain
because they can
purchase the good for
a lower price
SS
LS
P3
P1
D’
This gain in consumer
surplus is the shaded
rectangle
D
Q1
Q2
Quantity
Price Controls
Price
The gain to consumers
is also a loss to
producers who now
receive a lower price
SS
LS
P3
P1
D’
D
Q1
Q2
The shaded rectangle
therefore represents a
pure transfer from
producers to consumers
No welfare loss there
Quantity
Price Controls
Price
SS
LS
P3
P1
This shaded triangle
represents the value
of additional
consumer surplus
that would have
been attained
without the price
control
D’
D
Q1
Q2
Quantity
Price Controls
Price
SS
LS
P3
P1
This shaded triangle
represents the value
of additional
producer surplus
that would have
been attained
without the price
control
D’
D
Q1
Q2
Quantity
Price Controls
Price
SS
LS
P3
This shaded area
represents the total
value of mutually
beneficial transactions
that are prevented by
the government
P1
D’
This is a measure of
the pure welfare
costs of this policy
D
Q1
Q2
Quantity
Disequilibrium Behavior
• Assuming that observed market
outcomes are generated by
Q(P1) = min [QD(P1),QS(P1)]
suppliers will be content with the
outcome but demanders will not
• This could lead to black markets

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