Question

a)Explain the impact on a market of the imposition of a maximum price for basic foodstuffs .
b)Show the impact on the world market equilibrium price and quantity of oil due to an increase in economic growth in the world economy.

Answer 1

a)

The price control is restrictions on prices by government to maintain affordability of essential product, to combat inflation or to ensure a minimum income for the producers and suppliers of the good. The price controls can be of two types, price floor and price ceiling. The price celling is restricting price below equilibrium price to ensure the affordability of the good. Price floor is restricting price above equilibrium price to ensure minimum income for the producers and suppliers of the good.

The consumer surplus is the difference between market price and the price the consumer wants to pay. The price the consumer wants to pay for any particular unit is determined through the demand curve. The difference between the price the consumer wants to pay and the equilibrium price is given by the area enclosed by the demand curve and equilibrium price line.

The producers’ surplus is the difference between market price and the price the producer wants to receive. The price the producer wants to receive for any particular unit is determined through the supply curve. The difference between the price the producer wants to receive and the equilibrium price is given by the area enclosed by the supply curve and equilibrium price line. The total economic surplus in the economy is given by the consumer plus producers’ surplus.

Imposition of maximum price is equivalant to imposing price ceiling in the market for basic food stuff. The figure below gives the market for basic foodstuff:

Initially the demand curve in the market was D and supply curve was S. The equilibrium price was P_e and the quantity was Q_e. Now, let the government sets the price ceiling below P_e at P_c. The lower price will prompted the producers to decrease the supply. The quantity supplied fall below Q_e to Q_c. The fall in supply of the controlled priced good makes them hardest to find in the market.

Initially the consumer surplus was given by the area A+B+D. The producers’ surplus was given by the area F+C+E. The economic surplus was given as consumer plus producers’ surplus that is A+B+C+D+E+F.

The decrease in price decreases the producers’ surplus by the area C+E, now the producers’ surplus is F (area surrounded by price line P_c and supply curve). The decrease in price increases the consumer surplus by the area B+C (given by the area below demand curve and above price line up to the quantity sold in the market) and now it is given by area A+B+C.

The total economic surplus in the market with government control is given by the consumer plus producers’ surplus. The consumer surplus was given by the area A+B+C. The producers’ surplus was given by the area F. The economic surplus was given as consumer plus producers’ surplus that is A+B+C+F. The price floor decreases the total surplus by the area D+E. This area represents loss to the society and inefficiency in allocating the resources called the deadweight loss.