Suppose that the local government determines that the price of food is too high and imposes...

Suppose that the local government determines that the price of food is too high and imposes a ceiling on the market price of food that is below the equilibrium price in that locality. Predict some of the consequences of this ceiling

Solutions

Expert Solution

In following graph, price (P) and quantity (Q) of food are depicted vertically & horizontally respectively.

D0 & S0 are the demand & supply curves, intersecting at equilibrium point A with equilibrium price P0 and quantity Q0.

Initial consumer surplus (CS) = area between demand curve and market price = area AEP0

Initial producer surplus (PS) = area between supply curve and market price = area BEP0

A price ceiling is lower than equilibrium price at Pc. At this price, quantity demanded increases to Q4 and quantity supplied decreases to Q3, leading to a shortage of (Q4 - Q3). As consumers can buy only the quantity that producers will sell, market quantity traded is Q3.

New CS = area ACFPc, and we cannot determine if CS increases or decreases without numerical values.

New PS = area BFPc, so PS definitely decreases.

Deadweight loss = area EFG, which is the net loss to the society.

Rahul Sunny answered 1 year ago

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