Binding price ceilings have been used to protect consumers from “exorbitant” prices for many products such...

Binding price ceilings have been used to protect consumers from “exorbitant” prices for many products such as petrol and rental accommodation. In practice, however, such a policy quite often leads to making the community worse off. Use an appropriate diagram to discuss this issue. (100 words）

Expert Solution

The binding price ceiling is the maximum price set by the government below the equilibrium price that the sellers can charge.

Binding prices indeed protect consumers from paying exorbitant prices for products like petrol and rental accommodation. But the drawback of a binding price ceiling is that it creates a deadweight loss or the loss of social welfare.

Description of the diagram:

Before binding the price ceiling, the market for petrol or rental accommodation is in equilibrium. At point E. That is, the demand for petrol is equal to the supply of petrol. Equilibrium quantity and price are q and P respectively.

So in the case of petrol and rental accommodation, the government set a maximum price below equilibrium such that all consumers are protected from exorbitant prices. (price ceiling = P_C)

But when the maximum limit (price ceiling = P_c) is set below the equilibrium price P. The demand is more than the supply. (D>S). And this creates a problem of shortage, as a result, the new quantity sold and consumed is less than the equilibrium quantity. The society ends up consuming less quantity (q^c), the consumer and producer surplus decreases, which means that the total societal welfare has decreased. And the decreased social welfare is characterized as a deadweight loss.

Consumers are worse off as they get less quantity to consume. Moreover, suppliers also are worse off as they could gain more producer surplus under a competitive market.. So, the community as a whole is worse off by the binding price ceiling.

Rahul Sunny answered 1 year ago

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