Question

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

Answer 1

Price ceiling is the maximum price that could be charged. As shown in left figure market equilibrium price is P1 and price ceiling is set P0. After price ceiling price can not exceed P0. And effective price ceiling is set below the market equilibrium price. If price ceiling is set above the market equilibrium price, it will not be effective and does not have any effect on market.

Effective Price ceiling always creates shortage in the market because at price ceiling quantity demanded (decided by demand curve) is higher than quantity supplied( decided by supply curve). So it creates shortage as shown in left figure. C-D is shortage created by price ceiling.

Price floor is the minimum price that could be charged. Effective price floor is set above the market equilibrium price. If price floor is set below market price, than it will not be effective and does not affect market outcome. Price P2 is effective price floor in right diagram.

Effective price floor always creates surplus in the market. As shown in diagram at price floor P2, quantity supplied is higher than quantity demanded. So there is surplus equal to A-B.

2) Yes, these measures meddle with rationing function of prices.

Rationing function of prices says that in free market quantity demanded and quantity supplied determine the market price. Where quantity demanded equals quantity supplied price is decided. But these measures does not take care of demand and supply. These prices are determined arbitrarily. So these (Price floor and price ceiling) meddle with rationing function of prices.

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