A problem in Price Theory.
Here’s a question that I gave a number of my students in economics courses at the Naval Postgraduate School. If I recall correctly, a large percent of the students answered it correctly. And this was well before AI. (Of course, since it was on a problem set, they did have a few days to ponder.)
See how you do.
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.
In a few days, I’ll post the answer and try to use my cell phone camera to post a diagram of supply and demand.
Meanwhile, have at it, if you so choose.
READER COMMENTS
Craig
Jul 22 2025 at 8:58am
Not enough information? Shouldn’t I be asking where the proce ceiling is, ie above or below market equilibrium? Substitute products like Apple Juice and/or the elasticity of demand for orange juice?
Jon Murphy
Jul 22 2025 at 9:02am
All that information is given in the problem
Matthias
Jul 22 2025 at 10:00am
Some information is given in the problem. But eg we don’t know whether producers of orange juice have to buy their oranges under the same price ceiling and/or whether people who already own oranges are allowed to turn them into orange juice willy nilly. Nor do we know what the black market does.
Or whether orange juice is complementary or competitive with eating oranges.
To a certain extent making orange juice is most likely competing with eating oranges.
But we can also easily imagine that an orange tree produces perhaps 80% fruit that’s nice enough to show a customer, and 20% that’s not so nice looking and only fit for juice.
In that case, the juice industry would be complementing the oranges-for-eating industry as it would make use of an unavailable side product. Think like leather and meat.
And if a binding price ceiling would make growing oranges unattractive, then there would be no cheap third rate oranges for juice either. (Just like a price ceiling for meat might lead to less meat, and thus less leather.)
Jon Murphy
Jul 22 2025 at 9:05am
Hm. Well, the initial reaction would be to say “the price of oranges has fallen, and thus the supply curve of orange juice will rise, reducing price.” But, because of the binding price ceiling, there is is now a shortage of oranges in the marketplace. Consequently, even though the money-price of oranges falls, the full cost rises, which implies a declining supply curve, and higher price of OJ, ceteris paribus.
Warren Platts
Jul 22 2025 at 10:58am
It depends whether the price ceiling is applied to the orange growers themselves on a per tonne basis, or to the retail price of a single orange at the local grocery store. If the latter, orange growers will simply sell more of their oranges to juice producers, the quantity supplied will increase, the price of juice will decline. If the former, I guess that would result in a shortage of oranges altogether, thus the price of juice would be bid up.
Jon Murphy
Jul 22 2025 at 1:33pm
It’s applied to oranges. Let’s not overthink it.
John Hall
Jul 22 2025 at 9:28am
I am assuming that the price ceiling on oranges applies at the retail level for direct purchase and that orange farmers don’t have the price ceiling applied when making juice (as if there is an unmanipulated wholesale price or they make their own juice)
The binding price ceiling on oranges means that there is a shortage of oranges for direct purchase. Existing orange trees still produce their oranges, so there is excess capacity. The excess capacity can be used to make orange juice. This shifts the supply for orange juice to the right, resulting in a lower price and higher output of orange juice.
Craig
Jul 22 2025 at 9:35am
Would it apply in Brazil?
Matthias
Jul 22 2025 at 10:04am
I don’t know how elastic the supply of oranges is over different time horizons.
How much variable cost is there in tending to an existing orange tree to produce orange this season?
How long do orange trees last? How competitive are other uses cases for the land? Ie would farmers immediately plow under their trees and sell to property developers if the price of oranges dropped ever so slightly? Or would they not have much else going on and would keep farming oranges even if their price dropped to near zero?
Craig
Jul 22 2025 at 9:59am
Many many variables I would suggest that a price ceiling on oranges without a price ceiling on orange juice gives rise to a potential shunpike situation. Orange growers would become orange juice makers and orange juice makers would buy orange groves. There would be an incentive to vertically integrate the industry. People would be incentivized to avoid the price ceiling by not selling oranges….
Matthias
Jul 22 2025 at 10:07am
And it would depend on the relative demand for oranges-for-eating Vs oranges-for-juicing whether this scenario is important.
If orange juice is a weird niche product that only a few weird people consume, even if the price dropped to close to zero, that’s a different story to where everyone drinks loads and would drink even more, if the price dropped ever so slightly.
Matthias
Jul 22 2025 at 10:09am
More things we don’t know:
Are oranges the kind of good, where the producers can skimp on quality to drop costs? (And how quickly could they do it?)
Matthias
Jul 22 2025 at 10:12am
Also: is the price ceiling per kg or per piece?
For the latter, the producers might switch to smaller varieties? For the former, they would probably switch to more ‘watery’ varieties that grow more bulk even at the expense of taste. (And they might switch to selling you oranges on the branch, just like you can buy bunches of grapes with the little twigs still attached. Anything to drive up the mass.)
AMW
Jul 22 2025 at 12:55pm
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?
Henri Hein
Jul 22 2025 at 3:37pm
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.
steve
Jul 22 2025 at 6:59pm
I libertarian econ professor wants to know the results of a government intervention in the economy attempting to set some controls on the prices of a good. It goes up of course!
Steve
andrew weintraub
Jul 22 2025 at 9:35pm
Is the price ceiling on the retail price of oranges only? Or on the retail AND the wholesale price of oranges. It will make a difference.
Alan Goldhammer
Jul 23 2025 at 7:57am
The price of orange juice is directly linked to the price of oranges. If the price of oranges increases, the price of juice will as well. Topicana and other juice companies will arbitrage on world orange markets and purchase the lowest cost oranges for juice. It’s the same for almost any other agricultural commodity that is “freely traded (no tariffs).”
As everyone on this blog should know, this is not the case for sugar as the domestic sugar industry is propped up by quotas. Coca-Cola may or may not have said that they will be using American sugar in Coke rather than high-fructose corn syrup which in the US is less expensive because of quotas. Coke produced and bottled in Mexico exclusively uses sugar and the WaPo did a blind taste test the other day. 4 out of the 5 people were able to pick the Mexico Coke over the US corn syrup variety as better testing.
Warren Platts
Jul 24 2025 at 2:17am
Oh yes, Mexican Coca Cola is way better. If you can find it…
Jon Murphy
Jul 24 2025 at 8:11am
Another great example of the Protective Effect of a tariff.
Rob
Jul 25 2025 at 11:20am
The control of orange price reduces incentive to produce, so less is produced.
Orange juice makers will make juice with what they can, but fewer oranges means less orange juice.
People will still want orange juice, but with constrained supply prices will rise.
Some larger producers will ‘vertically integrate’, taking over orange production, removing the artificially skewed orange purchase from the equation and reducing the inefficiency. But there will also be a loss of efficiency in that small producers that had enjoyed a competitive advantage will be put out of work.
Other producers will focus on substitutes, as the price of orange juice is pushed artificially high. Hello, Sunny D.
Robert Kafader
Jul 28 2025 at 9:38pm
If the orange farmers are also making the orange juice, they would not be affected by the price limits. If the orange farmers sell their oranges to an orange juice producer, their pricing would be subject to the pricing regulations because they would be selling oranges, not juice.
Janusz
Jul 29 2025 at 12:32am
At first, before production is adjusted to new market conditions, the same amount of oranges is produced. Due to the price ceiling, the margin on oranges is significantly lower. Producers move as much inventory as possible into orange juice production to capture a higher margin. Because now there is much more orange juice being produced, the price of orange juice will fall. The price of OJ will fall to the new equilibrium between a much higher supply and the same demand, or to the level reflecting the same margin as on oranges.
Phillip
Jul 30 2025 at 12:48pm
Imposing a price ceiling on oranges will have the effect of lowering the supply of oranges. For a given demand of orange juice, if there are less oranges to produce orange juice then the price of orange juice will increase.
Comments are closed.