Question

Situation 4-1

During the winter of 1973-74, a general system of wage and price controls (including a price ceiling on gasoline) was in force in the United States. At the beginning of 1974, some oil-producing countries imposed an oil embargo (a legal prohibition on commerce) on the West. In the spring of 1974, price controls were abolished.

Refer to Situation 4-1. Before the oil embargo, the price ceiling on gasoline had no noticeable effect on the market. What is the most likely explanation for this?

a)The equilibrium price of gasoline was probably below the price ceiling.

b)The demand curve for gasoline in the 1970s was vertical.

Answer 1

a) The equilibrium price of gasoline was probably below the price ceiling.

In the above graph, PC is the price ceiling and P* is the equilibrium price, in this case, PC has no effect on the market. Only due to embargo will the supply curve shift left to increase the price in such a way that PC has an effect on the oil price.