Read the passage.

Markets, Prices, and Price Controls

ABSTRACT
This essay describes the concepts of supply and demand and elaborates on their relationship in a competitive market. It
details how the willingness of consumers to buy and of sellers to sell is dependent on price. The equilibrium price is
introduced , and it is shown to occupy a special point in market movement, the point at which supply matches demand .
The essay also examines attempts by governments to intervene in markets, usually to relieve the price pressure faced by
lower-income consumers as they try to secure essentials like housing, food, and hygiene products . The example is given of
price controls imposed by the Venezuelan government on toilet paper. The essay concludes with the contention that the
Venezuelan government's price­ control attempts were unsuccessful, generating market dynamics that were harmful to both
consumers and producers. The author generalizes from this case and contend s that markets should be left alone to reach
price points through the natural interplay of supply and demand .

1 Take a look around you at the kinds of products and services you usually consume. Focus on the clothes you are wearing,
the food you had for lunch, the phone you communicate with, and the computer you write assignments or play video games on.
Chances are that the vast majority of these goods and services were purchased in several markets.

2 What is a market? A market is a gathering of people. This gathering allows producers of a good or service to find buyers
who are interested in their good or service. A market can be local, such as your neighborhood mall or town farmers' market, or
much larger, such as global markets for different types of clothing, which involve sellers and buyers from all over the world. A
market can be physical, like a brick-and -mortar grocery store, or virtual, such as a website where you buy books or an online
broker service through which you purchase stocks and bonds.

3 Markets have existed for thousands of years, ever since humans discovered the advantages of specialization and trade
beyond their family unit or small tribe. Specialization means someone spends much of his or her time producing a good or
service that he or she is particularly proficient at creating. The next step in specialization is trade-finding someone who wants
that product or service. As the number of such specialties becomes larger and societies become more complex, markets become
more elaborate mechanisms for facilitating multi­ party trade among potential buyers and sellers. This complexity is far from just
a modem phenomenon, and there are notable examples in ancient civilizations of trade networks stretching thousands of miles
and involving scores of middlemen. Today's myriad markets both differ from and are remarkably similar to those of earlier
exchanges, in scale and sophistication.

4 A lack of complete self-sufficiency may seem like a weakness, but in fact it's not. Almost no one in a modern economy is
even close to being self-sufficient. To understand why, imagine what would happen if you had to create from scratch everything
that you consume. Imagine that you had to sew the fabric to get the shirt that you wear, and you also had to weave cotton to
create that fabric, and furthermore you had to plant and harvest the cotton that would eventually be part of your shirt. Imagine
that you had to create your phone from scratch, from the plastic or metal casing to the delicate electronic components inside, and
the smooth and delicate piece of glass that covers the screen. No single human being can produce the variety of goods we enjoy
today. Under a regime of self-sufficiency, one's pursuits would be incredibly narrow and even the most basic subsistence would
be difficult. We have achieved our current level of consumption and economic well-being through specialization and trade.
5 In this essay we will focus on how markets facilitate trade and let all of us-consumers and producers, society overall -
achieve better economic outcomes. A market attracts producers and buyers of a certain good or service. Within a market, each
producer is trying to maximize revenue from selling a product while each buyer is trying to pay as little as possible for a product.
Out of all market transactions, two critical numbers emerge. First, the number of units sold within a certain period of time, for
example, the number of cars sold in your hometown in a month or the pounds of tomatoes sold in your local farmers' market in
a day. The second important number is the price at which these transactions occurred. Prices may fluctuate across sellers and with
time, but at each point in time, the price of a good tends to converge to a certain value. The resulting price -when the quantity
supplied equals the quantity demanded -is called the equilibrium price.

6 Modern markets are very complex institutions, sometimes with millions of consumers and tens of thousands of sellers
in a single market, producing intricate behavioral patterns. As all scientists normally do, economists take this complex, real-life
situation and represent it with a model that captures the main features and allows us to understand what is going on and make
useful predictions. In this essay, we will focus on competitive markets ­ those with several sellers and buyers, all trading the same
product.

7 Economists represent the behavior of consumers in a competitive market through the demand curve, which states that
when the price of a product increases, consumers will buy fewer units (if nothing else changes simultaneously). For example, let
us say we are studying the market for medium-quality bicycles, and ten million bicycles are purchased when the price is $250. If
the price doubles to $500, then economists would expect to observe a decrease in the quantity demanded (e.g., to 8 million).
Graphically, the demand is a downward -sloping curve (Figure 1). Another way of interpreting the demand curve is that at each
point, it shows how much the last consumer was willing to pay for the last unit purchased. For example, the customer who bought
the very fast bike that was sold at a price of $250 (bike number ten million) was also willing to pay exactly $250. Consumers
higher on the demand curve have a higher willingness to pay (WTP) and thus would be willing to pay more than the market price
of $250. Consumers lower on the demand curve have a willingness to pay less than the market price of $250, and as a result, do
not buy a bike.

8 In a competitive market, producers are willing to sell more units of the good when its price increases. That behavior is
summarized by an upward-sloping supply curve (Figure 2). In our bicycle-market example, with ten minion bicycles being sold
at a price of $250, if the price of a bike doubles, then we would expect more bikes being offered in this market as more producers
enter the market. Just as consumers' willingness to pay is represented 011 the demand curve, the producers' willingness to sell
(also called reservation price} is represented on the supply curve. The producer's willingness to sell is based on the minimum
value he or she will accept in order to sell a good.
9 Given these representations of the fundamentals of the
behavior of buyers (demand) and sellers (supply), economists
analyze their impact on the market dynamics. In essence,
economists superimpose a supply curve on a demand curve to
find the point where the two intersect. If the price is high­ above
the intersection of demand and supply (as represented in
Figure 3)-sellers are offering more bicycles (Qs) than consumers
are willing to buy (Qi), resulting in a surplus. That surplus or
excess supply of bicycles means that bicycles are piling up in
stores, and to get rid of them, sellers are willing to lower the
price to attract more consumers.
As the price falls, the quantity of bicycles demanded increases, but at the same time, sellers are willing to sell fewer units.
Prices will continue to fall only as long as the quantity supplied exceeds the quantity demanded. This movement will stop when
the price reaches the intersection of demand and supply, where the quantity demanded and the quantity supplied are equal.

10 Similarly, if the price is low (below the intersection of demand and supply, as represented in Figure 4), consumers would
to supply fewer bikes. That creates a shortage of- or excess demand for - bicycles. Some of those potential buyers who would
like to have a bike but could not get one will be willing to bid up the price to buy a bike despite the shortage. As the price of
bicycles increases, producers will be wining to put more bikes on the market, and some consumers will decide not to buy any at
the higher price, reducing the shortage. The increase in prices will continue as long as there is a shortage, that is, until the price
reaches the intersection of demand and supply.

11 As you can see, whether the price is too high and there are too many bikes or the price is too low and there are not
enough bikes to satisfy the demand, the combined behavior of consumers and producers will push the price of a bicycle toward
the intersection of demand and supply. At that point there is no further incentive to change the price, and we have reached the
market equilibrium (Figure 5). The competitive market model predicts two specific numbers (the equilibrium price and the
equilibrium quantity) that we can test against a real market to see whether the outcome of our simplified representation is close
enough to real life.

12 Note that for all but the last unit sold at the market equilibrium, the willingness to pay (represented by the demand
curve) exceeds the market price. For example, if I use a bicycle to go to work as well as to exercise and I am willing to pay $700
for the bike, but I only end up paying the market price of $250, then I gain $450 (WTP $700 - Price $250) in the transaction.
Consumer surplus is the difference between what a consumer is willing to pay and what he or she actually pays. The aggregate
gains for all consumers in this market are represented by the area between the demand curve and the market price, as shown in
Figure 6. Likewise, producers enjoy similar gains because the market price exceeds their willingness to sell for all but the last
unit sold at the market equilibrium. Producer surplus is the benefit that a producer receives by getting more for his or her
product than the minimum he or she was willing to accept. The aggregate difference between market price and willingness to
sell is shown in Figure 7.
13 A fascinating aspect of competitive markets is that consumers and producers individually need very little information to
reach the market equilibrium. In fact, a person may be completely ignorant about what others are doing as long as he or she has
two pieces of information: his or her own willingness to pay (for consumers) or willingness to sell (for producers) and the market
price. The market price serves as a very accurate summary of the aggregate actions of all buyers and sellers in the market, and
that information, coupled with the individual, self-interested behavior of buyers and sellers, yields three results that are good for
society.

14 First, consumer surplus and producer surplus are maximized at the market equilibrium. How do we prove that? Imagine
a dictator who prevents market participants from selling- and therefore buying-as many u nits as in equilibrium. Because of this,
some buyers with willingness to pay above the market price will be prevented from buying the good (thus reducing consumer
surplus), and some producers with willingness to sell below the market price will not be able to sell their product (thus reducing
producer surplus). So reducing the quantity of goods to below the equilibrium quantity hurts both consumers and producers.

15 Conversely, if the dictator forces consumers and producers to buy and sell more units, for each unit beyond the
equilibrium quantity, some consumers will be forced to pay more than they are actually willing to pay (thus reducing consumer
surplus), and some sellers will be forced to sell at a price below their willingness (thus reducing producer surplus). Taking those
two scenarios together, if a forced decrease in quantity and a forced increase in quantity both result in producers as well off as
they can be, and that no amount of tinkering with the total quantity or the price will improve this outcome.
16 But is there any way to leave the market quantity untouched and just change the allocation among consumers or
producers, and increase the consumer or producer surplus? Let's tackle that question for consumers first. Each and every
consumer has the incentive to continue buying as long as the market price is less than or equal to his or her willingness to pay,
so the willingness to pay for the very last unit purchased by each consumer will be equal to or close to the market price. Each
consumer makes this decision independently, without knowing anyone else's willingness to pay; knowing just the market price
and one's own willingness to pay is enough. However, the combined result of these actions is that the willingness to pay of every
consumer is equal to or close to the market price, which also means that without any conscious coordination, everyone has about
the same willingness to pay for the last unit consumed. That, in turn, means that if you were to take one unit from one consumer
(thus hurting that person) to improve the welfare of another consumer (by adding one more unit to that person's consumption
at a lower willingness to pay), then you will hurt the first consumer more than you benefit the second one, thus reducing
consumer surplus. For example, let's say Jane and Paul are each buying two cups of coffee a day for $2 per cup, in equilibrium.
So both of them have the same willingness to pay the same amount for that second cup-$2. If you now forcefully take one cup of
coffee from Jane and give it to Paul for free, Jane loses her second cup (worth $2 to her) while Paul gains a third cup­ which will
be worth less than his second cup of coffee, thus less than $2. The competitive market equilibrium automatically guarantees that
there is no way to improve the welfare of any consumer without hurting others even more, a situation that economists describe
as an efficient allocation of goods across consumers.

17 Similarly, each and every producer has the incentive to continue selling as long as the market price is higher than or
equal to the willingness to sell, so the willingness to sell the very last unit created by each producer will be equal to or close to
the market price and therefore close to every other producer’s willingness to sell. If you attempt to improve overall welfare by
reallocating production across firms, you will hurt some firms who end up producing at a point where the market price is below
their willingness to sell. So, a competitive market also results in automatic efficient allocation of goods across producers.
Producers as well off as they can be, and that no amount of tinkering with the total quantity or the price will improve this outcome.

18 Let's recap: If anyone messes with the total quantity transacted in a competitive market, or if anyone messes with the
allocation of goods across consumers and producers in a competitive market, the result will be lower consumer and producer
surplus. No central planner can improve on the equilibrium outcome of a competitive market. The one critical piece of
information that allows this almost-magical result to happen over and over again across all competitive markets is the equilibrium
price . The price conveys to all consumers and producer’s essential information that allows them to reach maximum consumer
and producer surplus without central coordination.

19 Are all markets competitive? No. For several reasons, in some markets you may observe just one or two sellers, or one
or two buyers -for example, markets with goods that have relatively high fixed costs, like pharmaceutical products and electricity.
And the competitive markets' results may not apply to some special types of goods. But by and large, competitive markets are
efficient, resulting in the best allocation of goods and resources, maximizing consumer and producer surplus.

20 Despite the critical role of prices in competitive markets, sometimes governments prevent the price of a good or a service
from reaching its equilibrium, thus interfering with the information communicated across buyers and sellers. There are two basic
types of price controls: the maximum price or price ceiling, and the minimum price or price floor. The minimum wage and
the prices of raisins, milk, and some other agricultural products are all examples of price floors. At this point in our discussion,
we will focus our analysis on price ceilings, which include some notable examples, such as controlled rent and the prices of some
goods deemed to be necessities in a given location at a given point in history.

21 Price ceilings are meant to facilitate access to basic goods. For example, at this point in history, rent control laws in New
York City and San Francisco are politically important as city leaders try to make housing accessible to low-income households .
Similarly, the current government of Venezuela enforces price ceilings on coffee, bread, toilet paper, and other basic items in an
attempt to keep these goods relatively cheap despite the rampant rate of price increases throughout the country.

22 Inexpensive goods for everyone! What could be better? But do price ceilings actually achieve their goal? Furthermore,
how clod price ceilings affect consumer and producer surplus? Can price ceilings beat the market outcome without intervention?

23 Let's analyze price ceilings with our competitive market model. Figure 8 shows a competitive market
reaching equilibrium at consumer surplus is ambiguous: some (Pe, Qi). Let's say this is the market for toilet paper in Venezuela,
and the government imposes a price ceiling at Pmax. At this lower price, the quantity demanded increases and more consumers
would be happy to get toilet paper. However, producers would only be willing to sell a limited quantity of toilet paper at this
lower price. What does our model predict? A shortage of toilet paper. There will indeed be some lucky consumers who will be
able to buy toilet paper at the low price. But the limited supply will soon run out, and many consumers will be left without toilet
paper. In the absence of government intervention, the price of toilet paper would increase until the shortage disappears. But
raising the price of toilet paper is illegal in Venezuela, and anyone who attempts to get around this regulation risks
imprisonment. The net result is not at all what the government intended.

24 So we are stuck with a price ceiling for toilet paper. What are the consequences? First, since the quantity of toilet paper
produced and consumed is lower than n in equilibrium, the total surplus for society (consumer plus producer surplus) is smaller-
the Venezuelan society is worse off, a noticeable and unfortunate effect of the price ceiling. When loss of economic efficiency
occurs because equilibrium is not achieved, the result is deadweight loss. The shaded triangle in Figure 9 represents this loss.
25 Note that producer surplus is certainly smaller. On the other hand, the effect on consumer surplus is ambiguous: some
consumers benefit from the lower price, though only those who are able to buy toilet paper. But even for those consumers who
got to purchase some toilet paper, is the artificially low price their only cost? Unfortunately, not. Those consumers were able to
buy toilet paper by waiting in line for hours, trying to be one of the first people to enter supermarkets as soon as they opened to
be one of the few who could get their hands on a pack of toilet paper before the shelves were emptied. Figure 9 does not explicitly
show the cost of lining up and the uncertainty of getting toilet paper, but it is undoubtedly another disadvantage of setting a
price ceiling.

26 Producers who see their ability to charge higher prices curtailed may resort to reducing their cost by lowering the quality
of their product. In the case of toilet paper, we should expect the high-quality toilet paper to be displaced by thin and rough toilet
paper.

27 Last but not least, who gets the toilet paper? In a competitive
market, those buyers who value toilet paper the most would get it-
everyone with a willingness to pay above the market price. But the
introduction of the price ceiling means that many people who would be
willing to pay the price will not get toilet paper, and those who do get it are
not necessarily the consumers who value toilet paper the most. The price
ceiling has cost us not just our overall efficiency (the maximum total
surplus for society) but also the efficiency in allocation across consumers.
The combined loss is much larger than the deadweight loss represented in
Figure 9.

28 Did the predictions of economists play out in Venezuela? They certainly did. However, this phenomenon is not exclusive
to the price ceiling of toilet paper in Venezuela. It is observed in any competitive market with a price ceiling below the equilibrium
price. In some markets, like housing subject to rent control, beyond the short­ term shortage a misallocation of resources, the
prospect of permanently lower future rents reduces investment in housing, resulting in poor maintenance and long-term
shortages of good-quality housing in rent-controlled areas. Governments may introduce additional regulation trying to lessen
the negative impacts of price ceilings, but the only truly successful solution is the elimination of price controls.

29 In a nutshell, the argument against price controls is that they result in fewer people getting the products or jobs they
want. So, are economists who dislike them saying that we should abandon the goal of access to basic goods to all people? Not at
all. If that is indeed the societal goal, there are better, less costly ways of achieving it. Examples include a direct subsidy for low-
income people or better subsidized education that improves the opportunities of low-income people.

30 Why then do price controls exist at all? Because those who benefit, benefit in not insignificant ways and therefore tend
to fight hard to keep them. The few who can work at a higher wage, buy a good at a lower price, or sell a product at a higher price
may, for example, actively lobby government to keep the status quo. This occurs despite the harm caused to the many others
who, in the absence of such price controls, would also be able to work or buy or sell goods. In other words, price controls create
very visible, empowered winners -those who earn the higher wage, pay the lower rent, sell the more expensive product-and this
empowerment greases the gears of the political process that leads to price controls.