Water Scarcity and a Price Ceiling
After a hurricane cuts off the main highway into a city of 250,000, bottled water becomes scarce. Before the storm, stores sold about 300,000 bottles per day at $1 each. Now only 60,000 bottles per day arrive by air and back roads. Some stores raise the price to $6 per bottle. The mayor proposes a $1 price ceiling and says anyone charging more is 'gouging.' Economists on the council warn that a ceiling could create shortages and black markets. Meanwhile, hospitals and shelters need guaranteed water, and low-income households spend a larger share of their budgets on basic supplies. The council has $500,000 in emergency funds and must decide whether to impose the ceiling, use targeted subsidies, or do both. It also wants to avoid a public backlash.
1. Use supply-and-demand reasoning to predict two effects of the $1 price ceiling in the first week.
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At $1, quantity demanded would be near the normal 300,000 bottles per day, but supply is only 60,000, so the ceiling creates a shortage of about 240,000 bottles. One effect is non-price rationing: queues, limits per customer, and stores running out quickly, with some people who value water less getting it before others. A second effect is a black market or informal resale at prices above $1, because buyers will pay more and sellers can profit. The ceiling may also discourage suppliers from using expensive air and back-road transport, reducing future supply. The policy helps those who get water cheaply but does not by itself increase the 60,000 bottles arriving.
2. Explain how targeted subsidies or direct distribution could address equity concerns more efficiently than a universal ceiling.
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A universal $1 ceiling keeps water cheap for everyone, including people who could pay more, and it weakens the incentive to bring in costly supplies. Targeted subsidies or direct distribution can focus help on low-income households, hospitals, and shelters while allowing prices to reflect scarcity for other buyers. For example, the city could give vouchers or cash to low-income households and contract with suppliers to deliver water to shelters and hospitals. This preserves the signal to suppliers to bring more water and reduces the shortage. The trade-offs are administrative cost, the risk of missing eligible people, and possible fraud. But targeting is usually more efficient than a blanket price control when supply is sharply limited.
3. Recommend a policy mix and identify one trade-off.
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I would avoid a broad $1 ceiling for all buyers, or at most apply a temporary anti-gouging limit to essential bottled water while allowing higher prices for non-essential uses. The city should use the $500,000 for direct distribution to shelters, hospitals, and low-income households, and offer targeted vouchers so people can buy water without queuing. It should also publicly post price and supply information to reduce panic. The main trade-off is between speed and targeting: direct distribution can help quickly but may not reach everyone, while vouchers preserve choice but require verification and administration. A mixed policy also risks confusing the public about which prices are legal, so clear rules and sunset dates matter.