Question

1. The government is currently considering setting a maximum price (price ceiling) for basic goods to ensure that people can get access to these goods at this current time. Fully explain your answer and also use a single diagram to demonstrate the likely outcomes of this policy if the maximum price is set:

1. Below the current free market price                                              

2. Above the current free market price

3. At the current free market price      

Answer 1

Price ceiling is usually imposed by the government or central institutions to ensure that the essential commodities are reached to the consumer at affordable prices.

1. Below the current market price

If the price ceiling is below the current market price, it is binding and hence effective. This is because the maximum price charged would be less than the market price and hence the consumer would have to pay a lesser price. In such a case the demand is greater than the supply and there is shortage of good at this price.

2. If the price ceiling is above market price

This would be the case when price ceiling is ineffective as the maximum price charged is above the market clearing price and hence it is not binding.

3. When market price is same as price ceiling

In this case also it would have no effect on the market as the price is equal to the market price , so the maximum price charged is at market clearing price.

The graph below shows the price ceiling at various level .

P* and Q* are the market equilibrium price and quantity.

P1 is the price ceiling below market price and hence is effective.

P3 is at the market price and hence doesn't influence the market

P2 is above market price and hence non binding. The market would not reach till that level.

(You can comment for doubts)