5.1 Government-Controlled Prices

In a number of important cases, governments control the price at which a
product must be bought and sold in the domestic market. Here we
examine the general consequences of such policies. Later, we look at
some specific examples.

In a free market the equilibrium price equates the quantity demanded
with the quantity supplied. Government price controls are policies that
attempt to hold the price at some disequilibrium value. Some controls hold
the market price below its equilibrium value, thus creating a shortage at
the controlled price. Other controls hold price above its equilibrium
value, thus creating a surplus at the controlled price.

Disequilibrium Prices

When controls hold the price at some disequilibrium value, what
determines the quantity actually traded on the market? This is not a
question we have to ask when examining a free market because the price
adjusts to equate quantity demanded with quantity supplied. But this
adjustment cannot take place if the government is controlling the price.
So, in this case, what determines the quantity actually exchanged?