Question

Having confirmed the positive impact of widget-corn consumption on COVID-19 patients, the government has ordered widget-corn sellers to charge $5 per kilogram. What type of price regulation policy is this? Briefly explain. Calculate the impact of the policy on the quantity of widget-corn supplied and demanded. Explain the impact of the policy consumer surplus, producer surplus, and total economic surplus. Is the outcome of the government’s policy efficient and, therefore, maintained or abandoned? Explain in detail. please provide me with full answers

Answer 1

The State has imposed price ceiling as a regulatory measure to prevent suppliers from charging exorbitant prices for widget corn in the market ( due to the news that widget corn has good impact on COVID 19 demand would surge). Price ceiling are like price controls which is set usually for goods which are necessities and consumed by large section of people. If prices are or anticipated to be rising rapidly then it hurts existing consumers. Price ceilings therefore mandates suppliers the maximum amount that can be charged in the particular market.

When price ceiling is imposed there can be two consequences depending upon where it is set-

1. When price ceiling is not binding- Prices are set above equilibrium prices. This eventually raises price to higher levels where quantity demanded < quantity supplied.

2. When price ceiling is binding- Prices are set below equilibrium prices. This ensures that prices do not rise above set prices due to rise in quantity demanded. However it causes shortage of goods as at ceiling price, quantity demanded > quantity supplied.

Price ceilings distort market prices and create deadweight loss. In this example it will likely be set below equilibrium prices. It will raise consumer surplus, reduce producer surplus and creates deadweight loss or market inefficiencies. This is because when prices are set below equilibrium prices it becomes less profitable for suppliers to make the good available. So thete is a loss of producer surplus. However some of the surplus may pass on to the consumers in the form of lower prices. While the remaining surplus may not get materialized due to inefficient production and shortages of good. So the remaining surplus gets accrued to no one in the market and is a loss of opportunity to produce. Some producers may even leave the market because of not meeting costs at newly set prices. Others will find it less profitable so they may cut down on production. Therefore price ceiling are inefficient regulatory measure as total surplus ( that could have been generated by free markets) shrinks by the amount of deadweight loss. If the outcome of price ceiling leads to high shortage then the policy will be abandoned as the purpose of making the good available at greater quantities would not be served. So there will be a public policy failure. However if it is set exactly at equilibrium prices, the policy will be maintained.