What is the reason for the loss in consumer surplus as seen in the previous video (Analysis of a price cap)?

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BlackTom AI · Accepted Answer

This prompt provides a question without answer choices, so there are no options to evaluate individually. Instead, I’ll outline the key reasoning a student would use to explain why consumer surplus falls under a price cap, referencing the typical analysis shown in a price-cap video.

First, recall what a price cap does: when the cap is set below the free-market equilibrium price, it binds the market price and often creates a shortage because quantity demanded at the cap exceeds quantity supplied. This fundamental dynamic drives changes in surplus.

Next, understand consumer surplus (CS) as the area below the demand curve and above the price actually paid, up to the quantity traded. At the higher, unregulated equilibrium price, CS is larger because more units are traded and each unit is bought at a price closer to consumers’ willingness to pay.

Now, consider the impact of the binding price cap on quantity traded: the market moves from the equilibrium quantity to the lower capped quantity. This shrinkage in traded quantity reduces CS in two ways: (1) for the units that are no longer traded due to the shortage, there is a loss of CS equal to the area between the demand curve and the capped price over the now-missed quantities; and (2) for those who still buy at the cap price, CS for those units may not fully compensate for the foregone units.

Think about who loses CS: some consumers who valued each additional unit above the cap price would have bought at the higher equilibrium price, but because the cap limits the available quantity, these high-valuation buyers may be unable to obtain the good, resulting in deadweight loss and a net reduction in CS. Meanwhile, the few buyers who do secure the good at the lower price may gain on the units they purchase, but this gain does not offset the CS lost by those who are priced out or unable to obtain the good.

In addition, the shortage created by the cap can lead to non-price rationing (e.g., queues, favoritism, or search costs). Those frictions can further reduce CS by increasing the effort or time costs for buyers without increasing the amount of surplus captured by consumers.

If you’re asked to articulate the reason succinctly, you’d state: the binding price cap reduces the quantity traded relative to the efficient equilibrium, causing a loss of CS for buyers who cannot obtain the good and a reduction in the overall area under the demand curve that is captured as CS, with some corner gains for those who do obtain the good at the capped price not fully compensating for the foregone transactions and the resulting deadweight loss.

To connect to the video’s framing: the loss in consumer surplus is driven by the distortion of quantity supplied and the binding price, which prevents a portion of mutually beneficial trades from occurring, thereby shrinking the consumer-surplus triangle and creating inefficiency in the market.

ECO333H1 S LEC0101 Response Question 1 (Module 7)

What is the reason for the loss in consumer surplus as seen in the previous video (Analysis of a price cap)?

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