How price controls reallocate surplus | APⓇ Microeconomics | Khan Academy

What we're going to talk about in this video is the effect of price controls on changing how the surplus, the total surplus, is reallocated between consumers and producers. We already touched on this in other videos, the video on rent control, the video on minimum wages, and so this is to make sure that we are taking away some of the big ideas.

So right over here, I have my classic demand and supply curves for say, the rental market. At a high price, the quantity demanded is low and the quantity that people would be willing to supply is quite high. At a low price, the quantity that people would be willing to supply is low, while the quantity demanded would be quite high. We've seen from many videos so far in our journey through economics that we have our equilibrium price and our equilibrium quantity where these two curves or lines intersect. So I'll call this Q sub zero, and this is price sub zero.

But let's say, for whatever reason, city officials in this city, where this rental market that this chart describes, decide that P sub zero is too high. Their voters are complaining that rents are too high in the market, and so the city decides to put in a price control. In this case, they try to implement a price ceiling, so they say, "Look, the price of rent per square foot per month cannot go above this level right over here." So this is the price ceiling, right over there.

Now, what's going to happen here? Well, if this is the price ceiling, then right over here is the total amount of square footage, the quantity of square footage that is being willing that people are willing to supply. You could say landlords or building owners are willing to supply, but at this price, you have a much higher quantity that is being demanded. So this right over here is the quantity demanded, and when the quantity demanded at a price is higher than the quantity supplied, well then, you have a shortage. So this right over here is describing a shortage, and we talk about that in other videos.

But let's think about what's happening to the total surplus. So when we let the market just get to an equilibrium price in quantity, the total surplus—actually, let me just draw separately the consumer and the producer surplus. So this was the consumer surplus right over here before the government intervention, and then this is the producer surplus. We've talked about this in other videos. But now what happens when we have this price control? Well, this is the quantity supplied, and now all of a sudden the total surplus shrinks. The total surplus is now being depicted by this white trapezoid.

And also think about how things have shifted. So one thing that you see clearly, what is the producer surplus? Now the producer surplus is only this little yellow triangle, or this—I don't know my colors—this little blue triangle at the bottom. So you see very clearly that all producers suffer here; all producers suffer. Now you might say, "Well, of course, this is a rent control, but surely the consumers will benefit here." Well, it isn't the case. It is the case that some consumers, the ones that are able to get into a unit, they might benefit.

So this right over here—some demanders, or you could say some consumers, consumers benefit—but not all of the consumers benefit. In fact, you have a shortage. Now, before you had more people who were able to get housing, now these folks are not going to get the housing. As in all of economics, you should take a grain of salt in any type of oversimplified model like this, or simplified; this is actually a very useful model for thinking about certain things.

Because even these consumers that are benefiting, according to this model—for these consumers, it looks like their surplus has grown—or if you're this kind of marginal renter right over here, let me draw it over here—if you were the marginal renter that was before getting this much benefit, now you're able to get that plus all of that. But think about the things that this model is not capturing. What's the incentive for the landlord now? Would they want to invest in the building as much? Would they, or would they maybe let the building kind of suffer a little bit?

And there's also particular quirks for how rent control is implemented that might also change behavior. So always keep in mind that what's not captured by the model. But in broad brush terms, you put in a price control; in this case, you put in a price ceiling, you're going to create a shortage. All the producers are going to suffer; some of the consumers benefit according to this model, but not all of them, because not all of them are now going to be able to get a place to rent.

Now let's move over to another market. Let's say the corn market, and let's say once again we have our equilibrium price and our equilibrium quantity. So price of equilibrium, and this is our quantity sub-equilibrium. But let's say in this situation the government, let's say the corn farmers are able to organize and they're able to lobby the government and say, "Hey, we really suffer when there's low corn prices, so we want to institute a price control. We want you to institute a price control; we want a price floor."

So the government says, "Okay, corn farmers, you seem to be pretty serious about it, so we are going to institute a price floor." So the price cannot go below this level. So this is a price floor. Well, what's going to happen now? Well, let's think about the quantity demanded and the quantity supplied. So that right over there is the quantity demanded; we see where the price intersects the demand curve. And this right over here is a quantity supplied, where we're intersecting the supply curve, quantity supplied.

So in this situation, your demand is less; the quantity demanded is less than the quantity supplied. So in this case, you have a surplus. The farmers would want to produce more than people would want at that price, and I'll think about what happens to the total surplus and in particular the consumer and the producer surpluses. So in the old world, this was the consumer surplus, and this right over here is the producer surplus. In the new world, the total surplus shrinks; the sum of the two, we're now talking about this area of this trapezoid right over here, this sideways trapezoid.

And you see that all consumers suffer because now the consumer surplus has been shrunk. Right over there, the consumer surplus is right over here; there's consumers who are now not even consuming corn. And even the ones that are consuming corn before—let's say this marginal consumer right over here was getting all of this benefit; now they are getting a smaller benefit. So we could say all consumers suffer.

Now what about the producers? Well, the producers who are able to sell their corn definitely get a benefit. So if you were this marginal producer right over here, your surplus right over here would have been like that, but now you get even a higher price for it. And so one way to think about it is some producers—some producers for sure benefit according to this model. So let me write that: some producers benefit. But it's important to realize once again that not all of the producers benefit, because once again we have a surplus. If it's implemented this way, well, you might have a lot of farmers who aren't even able to sell their corn at that price.

So it's an interesting thing to think about. You should always take models with a grain of salt, but it is a pretty interesting framework where governments often will try to do some type of knee-jerk solution to try to make something look good or feel good to their constituents. But the end effect is that people might suffer more than they expect; it might cause a shortage when you put a price ceiling or it might cause a surplus when you have a price floor.