Price Ceilings: Lines and Search Costs

In this video, we explore two more unintended consequences of price ceilings: long lines and search costs. What was it like waiting in long lines for gasoline back in the 1970s? Not fun. But why did this happen? When price ceilings were imposed on gasoline, people could not use prices to signal how much they were willing to pay for gas. Instead, the only way they could show how much (or how little) they wanted of gasoline, was to wait (or not wait) in line. Going to fuel up becomes less about paying in money and more about paying in time. At the end of the day, paying in time is much more wasteful. In this video, we’ll show how to calculate the value of the time wasted in line. 

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- [Alex] In this video, were going to take
a look at another effect of price

ceilings: wasteful lines and other
search costs. Let's get started.

It's important to understand that price
controls do not eliminate competition.

Competition for scarce goods is an ever
present force under all forms of social

organization. What price controls do is
they change the form that competition

takes. So in a market, demanders compete
by pushing prices up. Suppliers compete by

pushing prices down. When we have price
controls, that shifting of prices is no

longer possible. But competition remains -
it just takes other forms. Here's an

example of musical chairs. The quantity
demanded exceeds the quantity supplied.

There's a shortage. But there's still lots
of competition, lots of scrambling to get

hold of those goods which are in short
supply. So lets take a closer look at some

of the forms that competition takes when
we have price controls and shortages.

So suppose there's a price control on
gasoline and oil, making it illegal to

compete for these goods by pushing the
price up. Nevertheless, there are other

ways of competing. Some buyers, for example, might
try bribing the station owners. This is not

necessarily the first thing which would
happen in the United States, but in other

places and countries this is extremely
common. Having a cousin who works in the

factory which is producing the good which
is in shortage is extremely important.

Using ones political connections, being
part of the political elite is

extremely important for obtaining goods,
which are in shortage. Even in the United

States, remember that firms also need
oil and gasoline in

order to operate. And in the
1970s when there was a

shortage of oil, firms appealed to the
Department of Energy, they lobbied their

Congressman and their Senator to obtain an
allocation of oil for their firm.

For consumers, another way to obtain the
good is to be willing to wait in line.

Now time waiting in line is also a cost.
So let's ask, "How long will the

line get?" We can use our model to
understand willingness to wait in line

and how long the lines will get.
Let's take a look.

So here's our supply and demand diagram
of the shortage. Remember that at the

controlled price we read the quantity
demanded off the demand curve, Qd, and at

the controlled price we read quantity supplied off
the supply curve, Qs. So Qs is the actual

amount of gasoline supplied given the
controlled price of one dollar. Now, here

is the key question: How much are buyers
willing to pay for a gallon of gasoline,

when Qs is the amount which is being
supplied? How much are buyers willing to

pay? What is the most they are willing to pay for
a gallon of gasoline? Well remember, we can

read that off the demand curve - that's
what the demand curve tells us. So at the

controlled price, when the quantity
supplied is Qs, buyers are willing to pay

$3 per gallon of gasoline. Theyre
only allowed to pay in money $1.

So, if a buyer were to obtain a
gallon of gasoline at a controlled price

of $1, that's actually worth to
them $3. That explains why

people are willing to wait in line for a
long time in order to get gasoline, because

the shortage has reduced the quantity
supplied. It's raised the

willingness to pay for gasoline,

but it hasn't raised the price of
gasoline. Therefore people are willing to

wait in line. And, in fact, the line
will grow until on the margin the

time price plus the money price will be
equal to the willingness to pay. So the

line will grow until the money price,
which is $1/gallon, plus the

time price, the time wasted in line, which
will grow up until it's $2/gallon,

until the total price equals the
willingness to pay. Why is that? Well,

imagine that that were not the case. Imagine
that you could obtain a gallon of gasoline

which is worth $3 for you. And you
only had to pay a dollar plus 50 cents

in waiting time. Well that would be a
great deal. So people will be willing to

wait in line so long as the total price,
the money price plus the time price, is

less than the willingness to pay. This
means that the line will continue to grow

until the total price is equal to the
willingness to pay. So, if we now take the

time price, which is the difference between the
willingness to pay and the controlled

price, times the quantity - that gives us the
total value of wasted time. So, another

effect of price controls - it creates long
lines in order to compete to get the good

instead of bidding the price up, they bid
in terms of being willing to wait in line.

And those lines are wasteful, creates a
lot of wasted time.

Let's take a look with a numerical
example. Okay, here's a simple numerical

example to bring this home. Suppose that
buyers value their time at $10/hour,

and that the average fuel tank holds 20
gallons. Now imagine that a buyer arrives

early at the gasoline station
and they wait one hour.

The total cost of the gasoline
is then $20, $1/gallon times 20

gallons in money cost,
plus $10 in time cost.

They waited an hour
and they value their time

at $10/hour. So the total cost of
the gasoline is then $30. It took

$30 worth of time and money in order to
get 20 gallons. So the implied cost per

gallon is $1.50/gallon. However,
remember that given the quantity supplied,

given the shortage, the value of
gasoline is $3/gallon. So this buyer

managed to obtain something which
is worth $3/gallon for only $1.50

per gallon. That's a good deal so other
buyers are going to bid up the price

by arriving earlier and earlier. And this
is going to push up the time cost. The

money cost is fixed because of the price
control, but the time cost can still

increase. In fact, the line will lengthen
until the total cost of obtaining 20

gallons of gasoline equals $60 or
$3/gallon. In other words, the

buyers will end up spending $20 in money
cost plus $40 in time cost, or four hours of

waiting. So we're able to calculate
approximately how long the line will get.

It will get four hours worth of time. So
this again illustrates that competition

does not go away when we have price
controls. Instead competition takes

different forms, and one of those forms is -
instead of bidding up the money price, the

time price is bid up and we get long and
wasteful lines. So what we've just seen

is that in a free market, buyers compete to
obtain goods by bidding up money

prices. And when we have price controls,
one way that buyers compete to obtain

goods is by bidding up time prices, by
being willing to wait in line. So what's a

better form of competition? Bidding or
paying in money or paying in time? Does it

make a difference? After all, some people
have got more money, some people have got more

time, is it just a matter of preference?
No. It is much better to have an economic

system where competition takes the form of
bidding in money than it takes the form of

bidding in time. Why? Paying in time is
much more wasteful. When you bid in terms

of money, the money goes to the station
owner. The money does not disappear. That

purchasing power is transferred from the
consumer to the producer. On the other

hand, when buyers bid in terms of time,
when they wait in line, that waiting in

line is just lost. It's not transferred to
the producer. When you wait in line for

four hours to obtain gasoline, the seller
of gasoline doesn't get to add four hours

to his lifespan. So that waiting in line
is just a total loss. When you pay in

money, the purchasing power is transferred
to the station owner. When you pay in

terms of time, the value of that time
is simply lost. It benefits no one.

Okay, quick reminder of where we are. Price
ceilings have five important effects. We've

looked at shortages and reductions in product
quantity. We've just completed wasteful

lines and other search costs. Up next,
a loss in gains from trade,

and then a misallocation of resources.

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