Why does a price ceiling below equilibrium cause a shortage?
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The question
We are covering rent controls. I understand that the diagram shows a gap between supply and demand, but I cannot explain in words why the shortage happens and where the deadweight loss comes from.
Short answer
At a price below equilibrium, buyers want more than sellers are willing to supply. The quantity actually traded falls to what sellers offer, so the gap is a shortage. The deadweight loss is the value of the trades that would have happened at equilibrium but no longer do.
Full expert answer
Economics tutor
MSc Economics, UCL
It helps to think about the two sides of the market responding to the same price separately, because a binding ceiling pulls them in opposite directions.
What each side does
- Demand: a lower price makes renting more attractive, so quantity demanded rises along the demand curve
- Supply: a lower price makes letting less profitable, so some landlords sell up or convert, and quantity supplied falls
- Trade: nobody can be forced to supply, so the quantity actually rented is the smaller of the two, which is the supply figure
The shortage is the horizontal gap between quantity demanded and quantity supplied at the ceiling price. In a rental market it shows up as waiting lists, informal side payments and people staying in flats that no longer suit them.
Where the deadweight loss comes from
Between the new, lower quantity and the old equilibrium quantity, there were renters who valued a flat above what it cost landlords to provide. Those mutually beneficial trades no longer happen. The triangle between the demand and supply curves over that range is the value lost, and it goes to nobody.
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