Question

4.1 In many developing countries such as South Africa, Botswana and Zambia, government intervenes in the setting of prices through price ceilings. Discuss the rationale of setting price ceilings in an economy. (10)

Answer 1

A price ceiling is a limit on the price of a good or service imposed by the government to protect consumers by ensuring that prices do not became prohibitively epxensive. For the measure to be effective, the price set by the price ceiling must be below the natural equillibrium price. A price ceiling is a type of price control, usually government mandated, that sets the maximum amount a seller can charge for a good or service. While they make staples affordable for consumers in the short term, price ceilings often carry long-term disadvantages, such as shortages, extrs charges, or lower quality of products. Economists worry that price ceilings cause a deadweight loss to an economy making it more inefficeint.

Rationale Behind a Price Ceiling

A price ceiling creates deadweight loss- an ineffective outcome. Althiugh deadweight loss is created, the governement establishes a price ceiling to protect consumers. An example of a ceiling price in the United States is rent control.

Rent Control in New York City

After World War II, soldiers were returning home from years of combat to start families. The influx of returning soldiers, created a high demand, landlords increased the price of rent to match the surge in demand.

However, the higher cost of renting resulted in unaffordable housing for soldiers returning from the war, especially since many were no longer receiving military pay. To address the problem. the government established a ceiling for rent charged to ensure that soldiers could find affirdable housing in New York

Although they are used to promote fairness, and protect consumers price ceilings that are set too below the equilibirum price and can be disastrous for producers. Unrealistic ceilings can destroy businesses and create an economic crisis.

Implications of a Ceiling

When an effective price ceiling is set, excess demands is created coupled with a supply shortage-producers are unwilling to sell at a lower price and consumers are demanding chaeper goods. Therefore, deadweight loss is created. If the demand curve will be net positive while the change in producer surplus is negative.

Graphical representation of a Effective Price Ceiling

For the measure to be effective, the ceiling price must be below that of the equilibrium price. The ceiling price binding and causes the equilibrium quantity to change-quantity demanded increases while quantity supplied decreases. it causes a quantity shortage of the amount Q dem-Qsup. In addition a deadweigh loss is created from the price ceiling.

Graphical Representation of an Ineffective Price Ceiling

A price ceiling is said to be ineffective if it does not change the choices of market participants. As illustrated above, an ineffective price ceiling is created when the ceiling price above the equillibium price. Since the ceiling price is above the equillibrium price, natural equilibrium still holds, no quantuty shortages are created, and no deadweight loss is created.