Question

Graphically explain price floor and price ceiling. Do these meddle with rationing function of prices? Carefully explain.

Answer 1

1 - Price floor is the price which is set above the equlibrium price . This is the minimum price to be charged from the consumer. Since this price is above the equilibrium price , demand is less and supply is more leading to the surplus in the market. The price needs to fall to bring the marker in equilibrium. Pf is the price floor

Price ceiling is the maximum price that can be charged from the consumer. Since this price is below the equilibrium price , demand is greater than the supply leading to shortage in the market. The price needs to rise in order to bring the market into equilibrium. Pc is the price ceiling. It leads to rise in consumer surplus and fall in producer surplus.

Price rationing is a tool which is used to allocate the scarce resources in the market without the use of price. But , in price ceiling and price floor , the main mechanism is all carried on the price setting. Hence price floor and ceiling contradict or meddle with price rationing.

The price floor and price ceiling can be shown as follows -