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      

2. The Australian government has implemented a number of microeconomic reforms over the past 40 years including deregulation of banking. Do you think banking deregulation has been beneficial or not? Explain your answer. Describe what you think may be the difficulties with microeconomic reform in Australia and highlight an area that you think currently requires microeconomic reform. Justify your answer.

Answer 1

Price Ceiling is a government imposed price control method to ensure that price of some necessary goods or services remain affordable for the people. It is primarily done to ensure the welfare of the poor section of society.

Below all the three cases have been discussed and explained:

Case:1 Below the current free market price

In a free market , equilibrium is achieved where the demand curve intersects the supply curve. When the government feels that the equilibrium price is a way too high for some section of the society then it imposes price Ceiling to prevent a price from rising above a certain level.

When a price Ceiling is set below the equilibrium (current free market ) price , then the quantity demanded will exceed quantity supplied and this will lead to situation where quantity demanded is more than quantity supplied. {Quantity demanded > Quantity supplied}.

This situation can be better explained through a diagram.In this graph the DD represents demand curve and SS represents the supply curve. On the X axis Quantity demanded and Quantity supplied is represented and Y axis represents the price.

In this diagram DD curve and SS curve intersects each other at point E as a result OP is determined as the equilibrium price.

Suppose that the government feels that the price OP is a way too high and decided to interfere in the market through the price Ceiling method and as a result fixes the maximum price i.e, price Ceiling at OP¹ which is less than the equilibrium price OP.

When price falls demand rises and supply falls. As a result producers are willing to supply OQ¹ and consumers are willing to demand OQ².

The effect of this price Ceiling is the shortage equals to CB which further leads to black marketing.Such kind of price Ceiling is known as binding price Ceiling.

Case:2. Above the current free market price.

When Price Ceiling is imposed above the equilibrium price then such kind of price ceiling doesn't changes the market outcome thus known as non- binding price ceiling.

For example: if the equilibrium price for pulses is 20 RS per kg and a price ceiling of 50 RS per kg is put in place, then nothing will change in the market i.e, such as an act of government will not lead to any excesses and shortages, since in this case the price ceiling says that the price cannot be greater than 50rs. So as a result the market price and quantity will remain the same.

In this diagram E represents the equilibrium point and OP represents the equilibrium price and OQ represents the equilibrium Quantity. OP¹ is the price ceiling imposed by the government which is not binding in nature thus the price and quantity remains at the equilibrium level.

Case:3. At the current free market price

When the ceiling is imposed at the equilibrium price than no changes will occur and market will remain in the equilibrium.