Explain how a price ceiling can lead to market failure with an example.

• A. It eliminates DWL.
• B. It creates excess demand (shortages), misallocation, and DWL.
• C. It guarantees efficient allocation.
• D. It increases supply until equilibrium.

Answer: (B)

A price ceiling that is set below the market-clearing price binds the market, so the price cannot rise to balance supply and demand. This creates excess demand, or a shortage, because more people want housing at the capped price than there are units available. With fewer units supplied and more buyers chasing them, resources are not allocated to those who value them most, leading to misallocation. Some trades that would have occurred at the efficient price never happen, producing a deadweight loss and a decline in overall welfare for society. A concrete example is rent control: keeping rents artificially low reduces landlords’ incentives to supply apartments and can degrade maintenance, creating long queues and black markets as people compete for scarce housing. This illustrates how a price ceiling can create market failure. The other options are off base because the ceiling does not eliminate DWL, nor does it guarantee efficient allocation, nor does it increase supply to reach equilibrium.