Effects of Government Regulation on Demand and Supply

A government can impose various restrictions that will lead to an imbalance in the quantity and price equilibrium resulting in a deadweight loss.

These interventions include:

  • Price ceilings and price floors
  • Taxes and trade restrictions
  • Minimum wages
  • Subsidies and Quotas

Price Ceilings

A price ceiling is the highest price at which it is legal to trade a particular good or service.

Assume that the demand and supply of housing determines the equilibrium rent of $550 a month and the equilibrium quantity of 4,000 units of housing.

The following graph shows the efficient housing market with maximum consumer and producer surplus.

Suppose the government imposes a rent ceiling of $400 per month which is below the equilibrium price. As a result the following changes happen.

  1. Rent ceiling restricts quantity supplied. Supplied quantity is 3000 and quantity demanded is 6000. Shortage of 3000 units.
  2. Rent ceiling creates a black market. Some people will be willing to pay $625 per month for a house.
  3. Resources get used in costly search activity including both time and cost.
  4. A dead weight loss arises.

Price Floor

A price floor makes it illegal to pay a price lower than a specified level. An example of price floor is minimum wage.

Let’s say the equilibrium wage rate per hour is $5 at the equilibrium quantity of 5000 workers.

Minimum wage is imposed at $7 per hour. The graph will change as follows:

  1. The minimum wage restricts the quantity demanded by the firms. At $7 per hour, only 3000 jobs are available.
  2. People will find it hard to find jobs, and some people will be willing to take a job at lower rate. Someone will be ready to take a job at $3 per hour also. Illegal wage rates will range from $3 to below $7.
  3. The firms’ surplus and the workers’ surplus shrinks.
  4. A deadweight loss arises.
  5. Other resources are used up in job search activity.


Taxes will increase the equilibrium price and decrease the equilibrium quantity, creating a deadweight loss.

Production Quotas

A production quota is an upper limit to the quantity of a good that may be produced in a specified time period.

With a production quota, the quantity decreases, the consumer surplus shrinks, the producer surplus expands, and a dead weight loss arises.


Subsidies are payments made by governments to producers such as farmers. Subsidies lower the prices paid by buyers and increase the prices received by sellers. With a subsidy, the quantity increases, and a dead weight loss arises due to overproduction.