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, we're 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 let's 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 one's 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 the quantity supplied

off the supply curve, Qs.

So Qs is the actual amount
of gasoline supplied

given the controlled price of $1.

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.

They're 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.

- [Narrator] If you want
to test yourself,

click "Practice Questions."

Or, if you're ready to move on,
just click "Next Video."

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