Price Ceilings: Misallocation of Resources

Suppose there is a mild winter on the West Coast and a harsh winter on the East Coast. As a result of the weather, people on East Coast will demand more home heating oil, bidding up the price. Under the price system, entrepreneurs will be incentivized to take oil from where it has lower value on West Coast to where it has higher value on the East Coast. But when price controls are in place, even though the demand is still there from the East Coast, there is no signal of a higher price, eliminating the incentive for entrepreneurs to transport oil from west to east. In fact, this happened in the 1970s, resulting in oil going to lower valued uses on the West Coast while many people on the East Coast didn’t have enough oil to heat their homes. In this video, we’ll look at a diagram to visualize this misallocation of resources.

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00:00 Introduction
00:35 Misallocation of resources example – oil across America
02:55 Misallocation of resources example – diagram
05:00 Loss from random allocation
06:08 Maximize consumer surplus
06:53 Comparing to random allocation
07:13 Best case scenario
08:01 Worst case scenario
08:35 Equal probability scenario
11:05 Recap: 5 effects of price controls