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♪ [music] ♪

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- [Alex] Today we'll be looking
at how price ceilings

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create what economists call
a "deadweight loss."

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This video will be short
since the ideas ought to be

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pretty familiar by now.

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Let's dive in.

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So let's remind ourselves
that when we have a free market,

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all of the mutually profitable
gains from trade are exploited.

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That's another way of saying
that a free market

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maximizes producer
plus consumer surplus.

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Now, when the mutually
profitable gains from trade

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are not fully exploited,
there's lost consumer

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and producer surplus,
or a "deadweight loss."

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The basic idea --
as long as the price

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the consumers are willing to pay
exceeds the price that sellers

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are willing to accept,

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there are mutually profitable
trades that can be made.

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And what we're going to show
is that price ceilings

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create a deadweight loss.

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Not all of the mutually profitable
trades will be made.

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Let's take a look.

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Okay, here's our standard diagram.

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I've just labeled some things
we talked about

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in earlier lectures,
mainly, the shortage

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of the controlled price
and the total value of wasted time.

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The key point for understanding
the reduced gains from trade

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is that at the free market
equilibrium,

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at this price and this quantity,
Qm, we have more units exchanged

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than at the price controlled
equilibrium.

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So with a free market,
we get Qm units exchanged,

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with a price control,
only Qs units are exchanged --

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a smaller amount.

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Now notice that these trades,
which fail to take place,

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they are mutually profitable.

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That is, the buyers are willing
to pay more for these units

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than the sellers require
to sell those units.

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So, because of the price control,
buyers and sellers are not allowed

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to come to a mutually profitable
deal at a price above,

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in this case, $1.

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They would like to, however.

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The buyers are willing to pay $3
for another gallon of gasoline.

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The sellers are willing to sell
that gasoline for $1.

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So there's a mutually
profitable trade.

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This trade would be worth $2
in mutual profit,

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to the buyers and sellers.

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They would like to make this deal.

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But it is illegal, it is illegal to sell 
at a price above $1.

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So these trades between Qm
and Qs do not occur.

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In a free market they would occur,
and because they would occur,

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they would generate
additional gains from trade.

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So compared
to the free market equilibrium,

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under the price control,
we have lost consumer surplus,

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in the amount of area A.

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And we have lost producer surplus
in the amount of area B.

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Together, A + B
is the lost gains from trade.

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These are the mutually profitable
exchanges which fail to take place

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because they're illegal,
because of the price control.

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So price ceilings reduce
the gains from trade,

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creating a deadweight loss.

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- [Narrator] If you want
to test yourself,

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click "Practice Questions."

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Or, if you're ready to move on,
just click "Next Video."

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♪ [music] ♪