Question

1. What is a price ceiling and what are the consequences of creating a price ceiling that is below the equilibrium price?
2. What is a price floor and what are the consequences of creating a price floor that is above the equilibrium price?

Answer 1

Price ceiling-

Price ceiling is the maximum legal price which the suppliers can charge for a particular good or service. It is the maximum permissible price. The suppliers cannot charge a price more than the price ceiling imposed. The government fixes the maximum price in order to freeze the price of a commodity. If the price ceiling is set below the equilibrium price, then at a lower price, buyers will demand for the commodity will increase and the suppliers supply will decrease. As such, quantity demanded will exceed quantity supplied and there will emerge excess demand or shortage of goods in the market.

The above graph shows a market where price ceiling is imposed. The market is initially in equilibrium at point E where demand equals supply. The equilibrium price is P and equilibrium output is Q. When a price ceiling is imposed of price P1, which is below the equilibrium price , quantity demanded is Q2 and quantity supplied is Q1. As quantity demanded is more than quantity supplied, shortage of goods will occur in the market . This shortage is equal to -

Shortage= quantity demanded - quantity supplied

Shortage= Q2-Q1

Shortage= AB.

hence, a shortage of goods equal to AB will occur.

PRICE FLOOR

Price floor is the minimum price at which the sellers may sell a particular good or service. It is also known as minimum support price. When price floor is set above the equilibrium price, buyers demand will decrease at a high price and suppliers Supply will increase at a high price. As quantity supplied is more than quantity demanded, there emerges excess supply or surplus in the market.

The above market shows where a price floor is imposed. The market is initially in equilibrium at point E where demand equals supply. Equilibrium price is P and equilibrium output is Q. When a price ceiling of price P2 is imposed, which is above the equilibrium price, quantity supplied is Q2 and quantity demanded is Q1. As quantity supplied is more than quantity demanded, excess supply or surplus will occur. This surplus is equal to -

surplus= quantity supplied - quantity demanded

surplus= Q2-Q1

surplus= CD

hence, a surplus of CD will emerge .