Price Ceilings: Misallocation of Resources
Suppose there is a mild winter on the West Coast and a harsh winter on the East Coast. As a result of the weather, people on the East Coast will demand more home
Suppose there is a mild winter on the West Coast and a harsh winter on the East Coast. As a result of the weather, people on the East Coast will demand more home heating oil, bidding up the price. Under the price system, entrepreneurs will be incentivized to take oil from where it has lower value on West Coast to where it has higher value on the East Coast. But when price controls are in place, even though the demand is still there from the East Coast, there is no signal of a higher price, eliminating the incentive for entrepreneurs to transport oil from west to east. In fact, this happened in the 1970s, resulting in oil going to lower valued uses on the West Coast while many people on the East Coast didn’t have enough oil to heat their homes. In this video, we’ll look at a diagram to visualize this misallocation of resources.
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I think that while misallocation of resources as described in the video is a very important (and often unduly omitted) point, it applies precisely to situations when goods are allocated to buyers in a totally random fashion, where there is no competition among buyers on other (non-price) margins - lines, bribes etc. On the other hand, if buyers engage in any activity to outcompete other buyers and secure allocation of goods to themselves, these very activities ensure that ultimately the goods will indeed end up in the hands of those buyers who value the goods most as they were willing to sacrifice the most. (These successful buyers will not be always the same group of people as their composition will be affected by the structure of the ultimate cost these buyers incur in getting the goods.) There would then be, strictly speaking, no misallocation of resources as described in the video. Would it be fair to say then, that unlike the DWL, the misallocation of resources is a consequence of price controls that is possible, but not necessary?
However there is random allocation on free market too. I mean the consumers with higher value uses than free market price. So the random allocation is on free market too, but only above the free market price. Am I right?
There is no random allocation on the free market compared to the controlled market.
On the free market demanders are free to bid up the price and suppliers are free to supply the product at however high price demanders are willing to pay. When suppliers see that a section of the demand curve (say, the section on the East Coast of the United States) is willing to pay more than the usual price, they rush to satisfy them first. Suppliers are able to see that Easterners are willing to pay more only because transactions on the East Coast show them that this is possible. But when transactions at a higher price than the controlled price are illegal, such don't occur. The only ones that do, are transactions at the controlled price. In this case suppliers are unable to detect which segment of demanders (East Coast, or West Coast) would be willing to pay more. For all they see, everyone across the United States only bids up no higher than the price artificially imposed. When that is the case, suppliers are going to continue to service both the East Coast and the West Coast. An Easterner would be equally likely to get the product at the controlled price as a Westerner.