THE SECRETS OF THE PERFECT DIAGRAM: AN EXAMPLE

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The government can prevent landlords from charging rents that are excessively high
by imposing a price ceiling. A price ceiling is a maximum price sellers are allowed to charge
for a good or service. It is effective so long as it is set below the free market equilibrium price.
In that case, consumers face a lower price, but they will have to cope with a persistent
shortage.

Figure 1: The effect of a price-ceiling on the market equilibrium

As depicted in Figure 1, the free-market equilibrium is at point E, where supply equals
demand. The equilibrium price is and the equilibrium output is . The introduction of a
price ceiling below creates a wedge between the quantity supplied and the quantity
demanded at that price. There is a shortage whose size is equal to because the
level of output that buyers are willing and able to purchase at the price ceiling exceeds the
level of output that sellers are willing and able to supply. It follows that only units of the
good or service will be traded after the price ceiling is imposed as buyers cannot purchase
more than sellers are willing to supply.
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