Question

Many people are concerned about the rising price of gasoline. Suppose that government officials are thinking of capping the price of gasoline below its current price. Which of the following outcomes do you predict will result from this policy? Check all that apply. [LO 6.1] a. Drivers will purchase more gasoline. b. Quantity demanded for gasoline will increase. c. Long lines will develop at gas stations. d. Oil companies will work to increase their pumping capacity.

Short answer

Options b and c: Quantity demanded will increase, and long lines may develop.

Step-by-step solution

Understanding Price Caps

A price cap is when the government sets a maximum price that can be charged for a product or service, which is below the equilibrium price. This often leads to a shortage as the quantity demanded increases while the quantity supplied decreases.

Analyzing Demand with Price Caps

When the price of a product like gasoline is capped below the equilibrium price, the cost becomes lower, and consumers will generally want to purchase more, leading to an increase in quantity demanded.

Identifying Supply Effects

Since the price is capped below the market price, suppliers might not be incentivized to provide more gasoline because their profits per unit sold will decrease, and they may not cover their costs, leading to a reduced incentive to increase supply.

Explaining Shortages and Long Lines

Given the increase in demand and the decrease in supply, a shortage results. Consumers may experience long lines at gas stations as more drivers compete for the limited gasoline available at the lower price.

Evaluating Oil Companies' Strategies

Oil companies are unlikely to increase their pumping capacity in response to a price cap, as they face lower revenues and possibly reduced profit margins. They would not invest in increasing capacity unless prices rise again.

Key concepts

Supply and Demand

Supply and demand are fundamental concepts in understanding economics. These principles define how goods are distributed in a market. - **Supply** refers to how much of a product or service is available for consumers. - **Demand** represents how much of a product or service people want to buy at a certain price. When the government imposes a price cap on gasoline, this cap restricts how high the price can go. Since the price is lower than what the market equilibrium would naturally dictate, more people want to buy gasoline because they're getting a "deal." This causes the quantity demanded to increase.
On the flip side, suppliers, such as oil companies, might not produce as much gasoline because they can't charge as much money, leading them to reduce the quantity supplied. This imbalance between high demand and low supply causes a shortage.

Market Equilibrium

Market equilibrium is a state in which supply equals demand for a particular good, resulting in a stable price. When you let the market flourish without interference, prices adjust naturally: if demand increases, prices often rise to encourage higher supply, and vice versa. Introducing a price cap disrupts this equilibrium. When gasoline is capped at a price lower than its equilibrium price, the market cannot reach its natural balance. This creates an artificial condition where, contrary to normal rules, supply cannot meet demand at the capped price. As a result, shortages occur, and consumers experience problems like long lines at gas stations. In this way, price caps can lead to frustration and inefficiencies in the marketplace.

Consumer Behavior

Consumer behavior refers to how individuals make decisions to spend their resources on consumption-related activities. When prices decrease due to a price cap on gasoline, consumers are more inclined to purchase additional gasoline as it becomes financially easier. They might even purchase more than they need because of the artificially lower prices. This behavior stems from the desire to take advantage of the lower cost, despite the reduced availability.
Due to this increased demand without a corresponding increase in supply, people face competition for the limited resources. This situation often results in long waiting times and inefficiency at gas stations. Therefore, while consumers aim to benefit in the short term through cost savings, they may face inconvenience and restricted availability due to the mismatch between supply and demand.