5. Government Intervention: The Cost of Interfering with Market Forces

Question 1

What is a price ceiling?

Answer 1

Represents a maximum allowable price imposed by the government.
o Imposed when the government believes $P is unfairly high (to protect low-income consumers)

Question 2

What is the deadweight loss with price ceilings?

Answer 2

• Price ceiling creates excess demand
• A certain group on consumers will be left unserved due to decrease in quantity supplied
  This is the deadweight loss

Question 3

Who are the winners and losers of price ceilings

Answer 3

Winners: those with high incomes - high willingness to pay

Question 4

Why are price ceilings inefficient

Answer 4

It reduces total surplus in the economy

If the government wanted to help the low-income households, a direct lump sum transfer to the poor is more efficient.
• Therefore this policy is likely to transfer surplus from the poor to rich instead of improving equity

Question 5

What is a price floor?

Answer 5

A minimum allowable price imposed by the government

o Imposed when government believes that $P is unfairly low, to protect producers in a certain sector