Onion Price Ceiling in a District Town
In a district town in Assam, the retail price of onions rises to ₹45 per kg in a bad harvest month. The district administration fixes a maximum retail price of ₹30 per kg and announces fines for overcharging. At ₹30, traders are willing to supply 800 quintals per day, while consumers demand 1,200 quintals. Before the ceiling, the market cleared at ₹45 with 1,000 quintals traded. Farmers say they will divert supplies to neighbouring districts where no ceiling applies; some retailers begin selling only to regular customers and charging extra for home delivery. The administration has a buffer stock of 150 quintals and can import from outside the state with a two-week lag. It must decide whether to keep the ceiling, switch to a targeted subsidy, or release buffer stock and let the price settle. Officials also worry about black marketing and quality deterioration.
1. Calculate the shortage at the ceiling and explain why the ceiling is binding. What happens to the quantity actually traded?
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At ₹30, quantity demanded is 1,200 quintals and quantity supplied is 800 quintals, so the shortage is 1,200 − 800 = 400 quintals per day. The ceiling is binding because ₹30 is below the equilibrium price of ₹45. At a legal maximum below equilibrium, suppliers offer only 800 quintals while buyers want 1,200. The quantity actually traded is the smaller of the two, 800 quintals, not 1,200. Before the ceiling, 1,000 quintals were traded at ₹45, so visible legal supply has fallen by 200 quintals. The unmet demand of 400 quintals creates queues, rationing, seller preference and scope for black marketing. Releasing the 150-quintal buffer would reduce the shortage to 250 quintals temporarily, but it would not remove the underlying price distortion.
2. Evaluate the three options: keeping the ceiling, releasing buffer stock, and a targeted subsidy. Which is least distortionary and why?
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Keeping the ceiling holds the price down but prolongs shortage, encourages diversion to neighbouring districts, black marketing and quality deterioration; supply may shrink further. Releasing 150 quintals adds supply and cuts the shortage to 250 quintals, but it is temporary and costly, and imports take two weeks. A targeted subsidy, such as a coupon giving poor households ₹15 per kg, allows the market price to rise while protecting the poor. It preserves the supply incentive and reduces queues and black markets. Its weaknesses are fiscal cost and targeting errors. The least distortionary option is a targeted subsidy combined with temporary buffer release and imports until supply recovers; a blanket ceiling should be avoided because it suppresses supply.
3. Why might farmers divert supplies to neighbouring districts? Connect this to opportunity cost and to the local supply curve.
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A farmer or trader can sell onions in a neighbouring district for about ₹45 per kg instead of ₹30 under the local ceiling. The opportunity cost of selling locally is therefore ₹15 per kg plus any transport saving. Rational suppliers divert output to the higher-price market. This is spatial arbitrage. As supplies leave the district, the local supply curve shifts left, so at ₹30 the quantity supplied falls below 800 quintals and the shortage worsens. A uniform price policy across districts, or official procurement at a support price, would reduce diversion. The episode shows that a price ceiling does not eliminate scarcity; it changes who bears the adjustment through shortages and non-price rationing.