Bahari County: A Price Ceiling, a Parallel Market and a Costly Buffer Stock
The county government of Bahari has fixed a maximum retail price of KSh 20 per kilogram of maize flour to protect low-income households. Weekly demand is estimated as Qd = 150 − 3P and weekly supply as Qs = 30 + 2P, where Q is in thousands of kilograms and P is the price in KSh per kilogram. Before the ceiling, the market cleared freely. Since the ceiling took effect, millers have been selling to favoured customers at KSh 20 while a parallel market has emerged at a much higher price, and queues have become normal. Officials are considering importing 20,000 kg a week and selling it at KSh 20; landed cost would be KSh 28 per kg. A consumer group argues the ceiling must be kept at all costs, while millers want it abolished.
1. Compute the free-market equilibrium price and quantity, and the size of the shortage created by the KSh 20 ceiling.
Read the worked answer
Equilibrium: set Qd = Qs:
150 − 3P = 30 + 2P → 120 = 5P → P = KSh 24; Q = 30 + 2(24) = 78 thousand kg per week.
At the ceiling of KSh 20:
- Quantity demanded = 150 − 3(20) = 90
- Quantity supplied = 30 + 2(20) = 70
- Shortage = 20 thousand kg per week (about 26% of the quantity that would clear the market).
Only 70,000 kg will actually be traded; the ceiling cannot force sellers to supply 90,000 kg at KSh 20. The 20,000 kg gap is what appears as queues and rationing by favouritism.
2. Estimate the price that would clear the parallel market at the quantity actually supplied, and the weekly deadweight loss caused by the ceiling.
Read the worked answer
Parallel market price: find the price at which demand equals the 70,000 kg actually available.
150 − 3P = 70 → 3P = 80 → P = KSh 26.67 per kg, roughly a third above the legal ceiling.
Deadweight loss: the welfare lost on the units that are no longer traded (from 70 to 78 thousand kg). The value buyers place on those units is read off the demand curve (between KSh 26.67 and KSh 24) and the cost of supplying them off the supply curve (between KSh 20 and KSh 24).
DWL ≈ ½ × (78 − 70) × (26.67 − 20) = ½ × 8 × 6.67 ≈ KSh 26,700 per week.
This understates the true cost, because it ignores the real resources consumed by queueing, bribery and the search costs of buyers who fail to obtain flour at all.
3. Advise the county on whether to import at KSh 28 and resell at KSh 20. Weigh the cost against the deadweight loss and consider who actually benefits.
Read the worked answer
Cost of the import scheme: 20,000 kg × (28 − 20) = KSh 160,000 per week, or about KSh 8.3 million a year, funded by the taxpayer. The scheme does close the 20,000 kg gap exactly.
Comparison: KSh 160,000 is roughly six times the estimated deadweight loss of KSh 26,700. The import does not 'save' that loss - it converts an invisible welfare loss into a visible budget cost, and it does so at a poor exchange rate.
Incidence: the benefit accrues to whoever obtains the imported flour at KSh 20 - in practice, those with queuing time, contacts or physical access, not necessarily the poorest households. Meanwhile the KSh 28 landed cost establishes an incentive to divert the imported stock straight into the parallel market at KSh 26.67, which requires rationing and enforcement.
Advice: do not treat the ceiling as untouchable. Better options, in order: (a) let the price move towards the market-clearing KSh 24 while monitoring retail margins, which removes the shortage and the parallel market at almost no fiscal cost; (b) if affordability is the real objective, replace the general subsidy with targeted cash transfers or vouchers to identified low-income households - this protects them while preserving the price signal; (c) if the ceiling must stay for political reasons, the import should be time-limited, rationed to registered households and reviewed weekly. Retaining the ceiling indefinitely with a permanent import subsidy is the most expensive of the options.