Question

Define a price ceiling and how it affects resource allocation in a market. Give a real world example of a price ceiling.

Answer 1

Price ceiling

A price ceiling is the maximum price imposed by government or any other authority on a good or service above which any seller could not charge any price to the consumers.

Price ceiling is generally imposed below the equilibrium price such that;

When price ceiling (Pc) is imposed below the equilibrium price level (P), as we can see the quantity demanded is more than the quantity supplied.

Qd > Qs

This means that there is excess demand in the market, i.e there is shortage of resources in the market.

A real world example of price ceiling can be price ceiling imposed on gasoline after shart increase in prices of oil. A maximum amount of gasoline price is set by government or other authority to control the rising prices. As price ceiling was imposed, it resulted in shortage in the economy as quantity demanded exceeded the quantity supplied. This step was taken to discourage the oil companies to maintain the production needed to face the interruptions in oil supply from Middle east.