Earlier this week, I posed the following problem in price theory.
The government imposes a binding price ceiling on oranges. But it does not impose any price ceiling on orange juice. After the price ceiling on oranges is imposed, what will happen to the price of orange juice? (Assume a competitive market for oranges.) Show your work.
I said I would post my answer. I also said that I would post a diagram of demand and supply. But the diagram got complicated because there are both demand and supply for oranges and demand and supply for orange juice. And, of course, while oranges are a crucial input into orange juice, oranges are also sold at retail as, simply, oranges.
The good news is that you don’t need to show the demand and supply for orange juice to get the answer. All you need do is recognize that a binding ceiling on oranges will cause the number of oranges produced to fall. That drives the result. You can show that result—the reduced number of oranges produced and sold—on a demand and supply curve for oranges, but you don’t need to. (I did have my students do it.)
When I taught the economics of binding price controls, whether price ceilings or price floors, the way I put it in my last 15 or so years of teaching is, “the short side of the market dominates.” If it’s a price ceiling, then the amount sold in the market is lower than if there’s no price ceiling; the supply side dominates—you can’t buy what no one is selling. If it’s a price floor, the amount sold in the market is lower than if there is no price floor; the demand side dominates—you can’t sell what no one is buying.
Now, back to the issue. With a smaller output of oranges produced, there will be less orange juice. The demand for orange juice is unchanged. (If it does change, it would rise as people realized that oranges are in shorter supply and so they substitute into buying orange juice; but this is a needless complication.) So with an unchanged demand curve for orange juice and reduced supply, the price of orange juice would rise. QED.
One commenter raised questions that are relevant to how much the price of orange juice would rise, but are not relevant to whether it rises.
AMW wrote:
Is this an open or closed economy? Is it possible to import/export oranges and orange juice? And how elastic are international supply and demand for oranges and orange juice?
All those are relevant questions for estimating the degree of increase. But let’s say orange producers export in order to avoid domestic price controls. That makes the domestic amount supplied even lower than otherwise and the price increase on orange juice even greater than otherwise.
Henri Hein put it well:
I’m with Jon Murphy and trying to keep it simple. With a price ceiling on oranges, the supply of oranges will fall. Presumably the demand for orange juice (at the price before the change) will remain the same. So the price of orange juice will have to rise.
Postcript:
One way to think about the problem is to think about the market for cars in 1946, after the U.S. government started allowing domestic car manufacturers to once again produce cars for the domestic market. Either car producers were hesitant to raise prices or remaining price controls forbade them from raising prices; I’ve forgotten which.
Either way, prices for new cars did not clear the market. So some car buyers would buy a car and “flip” it, that is, immediately sell at a higher price than they paid. Think of orange juice producers as “flipping” oranges.
READER COMMENTS
Don Dale
Jul 25 2025 at 6:05pm
Hi David,
I think one likely outcome is that orange producers will vertically integrate with producers of orange juice.
With a way to circumvent the ceiling, the vertically integrated firm’s production decisions can get interesting. I haven’t worked it out thoroughly and I’m sure it’ll depend critically on modeling assumptions, but my intuition is that the ceiling lowers the (opportunity) cost of using an orange to make juice, and thus we should think of the ceiling as perhaps increasing the supply of orange juice.
David Henderson
Jul 25 2025 at 9:10pm
I don’t think so, but I’ve had a long day flying and waiting in the Denver airport for my flight to Monterey.
I’ll think about it tomorrow when I’m fresher.
David Henderson
Jul 27 2025 at 1:09pm
You’re right that the price ceiling gives orange producers an incentive to vertically integrate into orange juice production. This will be a way around the price ceiling and, therefore, limits the damage done by the price ceiling. But if the result were a lower price of orange juice, that would mean there were unexploited gains from vertical integration before the price ceiling. The fact that the orange juice producers had not vertically integrated before implies that there weren’t such gains. So vertical integration can make the increase in the price of orange juice less than otherwise, but there would still be a price increase.
andy Weintraub
Jul 27 2025 at 9:06pm
That’s why I asked if the price ceiling was on both the wholesale and retail price of oranges.
If it was just on the retail price, then the supply of orange juice would shift to the right and the price of orange juice would fall.
David Henderson
Jul 27 2025 at 11:22pm
Ah, I think you’re right.
Jon Murphy
Jul 28 2025 at 8:42am
I’m not sure. Having orange farmers convert even part of their business to OJ production is not costless. To David’s point above, if there were gains there, the farmers would have been incentivized to do so before the price ceiling. So, prima facie, the marginal costs exceed the marginal benefits. After the price ceiling, some may try to circumvent the price controls by vertically integrating,* but to do so would still be more costly than existing OJ producers. The supply curve would still fall, but not as much.
*I don’t think it’s reasonable to assume such differential between retail and wholesale exists. A price ceiling on oranges means a price ceiling on oranges. The question does not distinguish between retail and wholesale, and nor should we.
Jon Murphy
Jul 28 2025 at 9:35am
Let me expand on my point:
We are told that the market for oranges is competitive. If orange growers can easily enter the market for orange juice, the market for orange juice is also competitive. Consequently, OJ producers are currently operating at zero economic profit and the minimum of the ATC curve. Increased output will not reduce average total costs, and a price decline will result in firms exiting the industry.
So, let’s say that orange growers enter the OJ market (ignore the price control for now). If the supply increases and prices fall, some existing firms will necessarily shutdown (P<ATC). The supply curve will go back to its original position.
But, with the price control on oranges, the supply is decreasing, putting pressure on prices to increase.
So, assuming orange growers enter the OJ market to avoid price controls (an assumption unjustified by the problem, I hasten to add. There are a myriad of ways they could adjust, and no particular reason to assume this method is the best), the equilibrium price will rise or, at best, remain unchanged.
The only way for the supply curve to increase in this situation would be something exogenous that drives down costs so that new firm entry can be accommodated.
Jon Murphy
Jul 28 2025 at 9:37am
Note that if the market for OJ was not competitive (a monopoly), then the supposition is irrelevant. Barriers to entry would prevent orange growers from entering the OJ market.
Craig
Jul 25 2025 at 9:47pm
A company like Tropicana might initially be happy about the price ceiling until there is a shortage. Company buys a significant percentage of all the oranges grown in FL. Depending on the severity of the price ceiling those growers have an immediate incentive to make juice though. One might see more companies like Natalie’s or juicers that don’t buy the oranges but simply take the oranges and produce private label orange juice for the growers. Perhaps co-op style? One important aspect I would suggest is orange groves can’t just be switched to other uses very quickly.
Craig
Jul 25 2025 at 9:28pm
With a price ceiling on oranges, but not orange juice, its quite possible that more oranges will get turned into juice. One could wind up with fewer oranges but more orange juice.
Jon Murphy
Jul 25 2025 at 10:59pm
Again, there are fewer oranges, resulting in lower supply of orange juice. Price rises. Draw it out.
Craig
Jul 26 2025 at 12:05am
Right now 80% of oranges get turned into juice according to a quick google. So let’s just say we have 1000 oranges grown and 800 go to juice. Now 200 are left now subject to a price ceiling. Now maybe fewer oranges are grown so now 900 are grown, but it could be 850 go to juice because the growers are incentivized to turn it into juice first before selling it. So you could get fewer oranges available for sale but more orange juice available for sale.
Jon Murphy
Jul 26 2025 at 5:57am
You’re smuggling in a lot of assumptions not in the problem. Keep it simple and just go with the logic.
Jon Murphy
Jul 26 2025 at 10:33am
I did the math. Your outcome is quite impossible given the conditions of the market. One cannot get a market clearing quantity of 850 oranges for orange juice given a price control.
Craig
Jul 26 2025 at 12:25pm
“I did the math.”
You’re making stuff up
“Your outcome is quite impossible given the conditions of the market.”
We don’t actually know the conditions of the market. This didn’t actually happen so they didn’t run the experiment.
Facing a price ceiling growers will not grow as much, grow it anyway and sell it ‘as an orange’ at the price ceiling AND/OR juice more. And you have zero, none, absolutely no idea in what proportion those growers will choose those options. But given how growers are invested in fields, trees that take time to grow, machinery dedicated to oranges, etc juicing the oranges seems to make sense.
“One cannot get a market clearing quantity of 850 oranges for orange juice given a price control.”
I can’t believe you even wrote that sentence remotely thinking its valid argumentation of any sort. The point is that right now 80% of the oranges grown go to juice, in the face of a price ceiling its very possible 95% of all oranges grown might get juiced. I mean we could even hypothesize that the price ceiling is a nickel per orange and at that point near 100% of the oranges will get juiced. We don’t know not the least of which we don’t know the severity of the price ceiling itself. So we can ponder the ponderables.
“You’re smuggling in a lot of assumptions not in the problem. Keep it simple and just go with the logic”
No I’m not.
The problem goes out of its way to emphasize: “The government imposes a binding price ceiling on oranges. But it does not impose any price ceiling on orange juice.”
The second I read that I thought, “Ok, there’s a price ceiling but it can be circumvented”
The price ceiling on oranges can be circumvented by juicing them.
You can either acknowledge that as a good point that other posters here have noted independently or not, at this point.
Jon Murphy
Jul 26 2025 at 12:43pm
Rude. Draw it out if you don’t believe me.
Yes we do. They’re given explicitly in the question.
Yes we do. Again, given explicitly in the problem.
Yes you are. That’s why I’m telling you to draw it out. You’ll see the hidden assumptions come to the fore. Not the least of which assumption is that the farmers can circumvent the price control by juicing. That’s a huge assumption and one that is explicitly false in the problem.
Reread the problem carefully. Use only the assumptions on it. Draw it out. If you find yourself having to add in complications, stop yourself and remind yourself to focus just on the problem. Not “what ifs.”
There is only one way that we can have a situation where the new market clearing quantity is higher than where it was: of the demand or orange juice simultaneously increases as the supply falls. But any increase in demand is exogenous and violates the conditions in the problem.
Jon Murphy
Jul 26 2025 at 1:19pm
Another tool to help you think through these problems (in addition to what I say below in your response to Bill):
Remember basic probability: the more conditions are attached to something, the less likely it is to be.
Consider this. What is more likely: A) That a person is a banker, and B) that is a person is a banker and fiscally conservative.
The answer, of course, is A (except in an edge case where every banker is fiscally conservative). B can never be more likely than A because B has more conditions than A.
As you need to add more and more conditions to get a desired solution, the less likely it is that the desired solution will be correct.
That is why in the other comments section (and with my students), I kept stressing to keep it simple. Other commentators may have thought your conditions were possible given the question, but the economists all disagreed.
Craig
Jul 26 2025 at 1:26pm
“Not the least of which assumption is that the farmers can circumvent the price control by juicing. ”
They can and will do just that to some extent.
“That’s a huge assumption and one that is explicitly false in the problem.”
No its not, its a prediction based on the fact that the price ceiling creates the incentive to do it.
“one that is explicitly false in the problem.”
No it does not say that. Again you’re just making stuff up. The problem isn’t very specific at all actually.
John Hall
Jul 25 2025 at 9:44pm
I don’t think you’re taking into account that the orange trees are capital. There is already an up front investment in them. They’ve been planted. I don’t doubt that there’s a cost associated with producing the fruit (both maintaining the trees and picking the fruit) and an opportunity cost for what you could do with the land otherwise. There could be a different short term effect than long term effect because farmers will pick oranges if they think they can cover their costs if they have fruit at an intermediate stage. Your result might hold more in the long run.
I was thinking about it in terms of two markets. The direct orange market and the orange juice market. But it may be cleaner to think about it in terms of three markets, by adding in a wholesale market that feeds the direct and orange juice markets. Your argument in this context could be that the binding price ceiling in the direct market induces a leftward shift in the wholesale supply curve and then that induces a leftward shift in the orange juice supply,
Robert EV
Jul 25 2025 at 10:02pm
The original post got nit-picky quick, so I didn’t post. I thought the same as your first paragraph.
I was wondering, though, whether price controls on oranges would encourage more selling of oranges at farmer’s markets, U-Pick-It orchards, and home juicing machines. Even with that I’d still imagine a long-term decrease in non-imported oranges and orange juice, without needing to factor in greening disease or drought.
Jon Murphy
Jul 25 2025 at 11:00pm
In the long run, the shortage gets worse. But there is still a shortage in the short run.
Alan Goldhammer
Jul 26 2025 at 5:14am
Tangential to David’s original post is the loss of US orange production resulting from disease and destruction of orange groves for real estate development. The Irvine Ranch area of Southern California where co-blogger Scott Sumner lives had significant citrus production in the 1950s as could be seen when traveling from San Diego to Los Angeles. That’s pretty much disappeared as housing has replaced the trees. California had a significant orange juice industry. IIRC the TreeSweet brand of frozen concentrate that we had in our house came from California trees (they also had frozen lemonade concentrate).
Bill
Jul 26 2025 at 10:14am
Consider the orange juice supply curve. Following the imposition of a price ceiling on oranges, one would expect the supply curve for orange juice to shift rightward as the price of one of the key factors (oranges) is now lower priced. Taken by itself, this would lead to lower priced juice. But, with fewer oranges available due to the price control, juice producers will not be able to acquire all the oranges they demand at the lower price, thus constraining the supply of juice and putting upward pressure on juice price. Solve for the equilibrium.
Craig
Jul 26 2025 at 12:29pm
“But, with fewer oranges available due to the price control, juice producers will not be able to acquire all the oranges they demand at the lower price”
But the price control can be circumvented by juicing so we could get fewer oranges sold as oranges but more oranges turned into juice. Indeed on the demand end consumers of oranges facing the orange shortage might then substitute to orange juice as well.
Bill
Jul 26 2025 at 12:47pm
Vertical integration i.e., orange growers are juice makers?
Craig
Jul 26 2025 at 1:14pm
Most are to some extent, famous one in FL is Natalie’s, but it can go either way. Let’s say the government made a $.01 price cap on oranges. Nobody is going to sell an orange for a penny, right? What do you think Tropicana is going to do, go out of business? No, before the ink is dry on the statute they’ll lease the grove and subcontract the orange farming to the landowner leasing the grove to Tropicana and/or actually acquire groves (they might not want to do that). There wouldn’t be any oranges for sale at the store, but there’d still be orange juice and the activity of juicing won’t be competing for oranges with the sale of ‘loose oranges’
Jon Murphy
Jul 26 2025 at 1:07pm
There are two of your hidden assumptions. Note the conditionals you must use (bolded by me).
Here’s a good trick to use when thinking through these problems to see if you are smuggling in assumptions:
For each claim you make, point to what in the problem justifies that claim. For example, point to the part of the problem justifies the claim that demand for OJ is increasing.
Craig
Jul 26 2025 at 1:17pm
“For each claim you make, point to what in the problem justifies that claim. ”
Because if the consumer wants an orange at the price ceiling and can’t find it its not unreasonable to assume that some percentage of those people who want the orange but can’t buy it might settle for orange juice. I’m suggesting that orange juice might be a substitute for oranges to people incapable of procuring oranges. Hardly controversial.
Jon Murphy
Jul 26 2025 at 1:22pm
True, but again that is an assumption you have to smuggle into the problem. If you cannot justify the assumption from something in the problem, it is a bad assumption and should be tossed out (also, note the conditional, highlighted again).
You can add in infinite assumptions. That’s trivial. But you are not answering the question. Yes, if conditions were different, the answer would be different. And if my grandmother had wheels, she’d be a bike.
I see my students do this all the time. They change the question, answer their question, and wonder why they get a zero. It’s because they didn’t answer the question posed.
Craig
Jul 26 2025 at 1:39pm
“True, but again that is an assumption you have to smuggle into the problem.”
No we’re not, the problem is asking “After the price ceiling on oranges is imposed, what will happen to the price of orange juice?”
The point about orange consumers is incidental only. Its a potential second order effect which would tend to make the price of oj a bit higher
To avoid the price ceiling, make juice. You don’t know which way it goes, the issue is whether there is more juice or less juice.
That is entirely dependent on the propensity to avoid the price ceiling.
You don’t know what that is.
Robert EV
Jul 26 2025 at 8:08pm
A sincere question: In a deflationary economy, or at the least an economy that’s deflationary for the production costs of oranges, does a point ever come where where a price control would encourage production of oranges?
I’m imagining this as the orange producers keeping the price of oranges at the price control point, and rarely or never discounting them. as the net profit on the oranges increases they’d grow, import, and otherwise seek to sell more of them. At some point people would stop buying the oranges (assuming that the deflation is general, the oranges would become relatively more expensive than substitutes), so you’d get increased waste and eventually either reach an equilibrium, or the producers would start discounting prices below the price control level.
But I’m just wondering if the intermediate, and even ultimate, level of production could exceed what would otherwise have been the case in a free market. If only through availability bias (sometimes people will buy what’s in front of them, not what they actually want, e.g. Hobson’s choice).
Robert EV
Jul 26 2025 at 8:37pm
And a second sincere question, which can presumably be answered from historic mining data: When the price of gold was fixed to the dollar, did this increase or decrease the production of gold?
I assume this would be a question that economists really paid attention to, as it’s the most obvious, long-term, and worldwide case of price fixing in history.
Bill Conerly
Jul 27 2025 at 11:44am
I think there is confusion here about changes in the supply curve and movement along the supply curve. In competitive markets, the supply curve is the marginal cost curve (that portion above average variable costs). Nothing in the marginal cost curve has changed.
The supply curve is typically drawn with a J shape. We get different results for the orange problem depending on where we are on the curve. The downward-sloping portion of the curve reflects economies of scale as quantity increases. The upward-sloping portion reflects the need to bid resources away from other uses.
First let’s take the case where we are in the upward-sloping portion of the supply curve. The imposition of the price ceiling does not change marginal costs. Producers decline to sell some of their production at the controlled price because the controlled price is below marginal cost. So producers supply a lower quantity. Their marginal cost falls as they move down the supply curve. Juice consumers are still willing to pay based on their prior demand schedule (unless we want to consider consumer substitution). The new equilibrium orange-for-juice price is below the old market price because of the lower marginal cost.
News reports might describe producers as preferring to dump their product onto the juice market rather than sell in the controlled market. If the controlled price is low enough, the direct sale of oranges could end completely.
Now let’s consider if the industry was in the downward-sloping portion of the supply curve. Reduced production raises marginal costs, because there are now fewer economies of scale. Juice market price will rise. News reports may say that the market has shifted from mass production to artisanal production.
Markets most often are in the upward-sloping portion of the supply curve, so the most common result would be lower prices for the juice market.
It is incorrect to think of the supply curve as shifting to the left. In the upward-sloping portion of the curve, a leftward shift is the same as an upward shift. So asserting that the supply curve shifts left is equivalent to saying that for any given quantity, the marginal cost has increased. That is not the case.
I also failed to come up with a workable graph that would describe the entire problem. Perhaps someone can work up the algebraic approach.