Question

The government set a maximum price for bread which is lower than the price that was set in the bread market before the government intervened.

a. Show that in this situation the bakers will not be willing to sell the entire quantity the consumers would like to buy.

b. In your opinion what will happen if the government shall not take any additional steps to support its policy and will only voicing the demand of the maximum price?

Answer 1

In the graph below DD is the demand curve and SS is the the supply curve. Before government intervention through the forces of demand and supply price is  P1 and Quantity is Q1.

Now suppose government set a maximum price for bread which is lower than the price that was set in the bread market before the government intervened. So the maximum price set by the government is P*.

a. At price P*, Consumers are demanding Qd quantity. But as prices are low so some of the producer are not able to at this quantity so this will cause supply of Qs which is less than the quantity demand. To fulfill demand of the consumers, Suppliers required to supply Qd units which is possible only if price is P** and at the maximum prices if they fulfill consumer demand they will face losses.

b. At maximum price P*, Qd > Qs which implies an upward pressure on prices that this situation of excess demand cause rise in prices. Rise in price cause supply to increases (an upward movement along SS curve) and demand will fall (upward movement toward left along DD curve) this will continue till the initial prices P1 will achieve.

So If the government shall not take any additional steps to support its policy and will only voicing the demand of the maximum price. It will cause prices to rise to restore the price before government. intervention.