Introducing Supply and Demand

Example – Price Ceilings and Deadweight Loss

The chart above shows what happens when a market has a binding price ceiling below the free market price. Without the price ceiling, the producer surplus on the chart would be everything to the left of the supply curve and below the horizontal line where y equals the free market equilibrium price. The consumer surplus would equal everything to the left of the demand curve and above the free market equilibrium price line.

With the price ceiling, instead of the producer's surplus going all the way to the pareto optimal price line, it only goes as high as the price ceiling.The consumer surplus extends down to the price ceiling, but it is limited on the right by Harberger's triangle. In this case, the reason for that limitation is due to quantity produced. The consumer would purchaser more of the product at the ceiling price, but the producers are unwilling to supply enough to meet that demand because it is not profitable. As a result all of the goods that might have been produced and consumed if the good was priced optimally are not, representing a net loss for society.