Question

With the aid of supply and demand diagrams demonstrate that any and all effective price controls in a competitive market will reduce the actual quantity that can be traded (i.e. bought and sold) in that market.

Answer 1

In following graph, price (P) and quantity (Q) are depicted vertically & horizontally respectively. D0 & S0 are the demand & supply curves, intersecting at equilibrium point A with equilibrium price P0 and quantity Q0.

(I) Price floor

An effective floor price is higher than equilibrium price, at Pf, at which, quantity demanded decreases to Q1 and quantity supplied increases to Q2, causing a surplus of (Q2 - Q1). Since producers can sell only what consumers will buy, market quantity traded is

Q1 = min(Q1, Q2) = Q1 (< Q0).

(II) Price ceiling

An effective floor ceiling is lower than equilibrium price, at Pc, at which, quantity demanded increases to Q4 and quantity supplied decreases to Q3, causing a shortage of (Q4 - Q3). Since consumers can buy only what producers will sell, market quantity traded is

Q1 = min(Q3, Q4) = Q3 (< Q0).