A2.04.07: Price Ceilings

Question 1

Define Price ceilings

Answer 1

Enacted by the government and usually set below the equilibrium market price. Price charged must not be higher than the legal maximum price.

Question 2

Illustrate the diagram for Price ceilings and describe it

Answer 2

• Maximum price line drawn at a lower price Pc (price ceiling)
• The point below social optimum is excess demand / shortage
• S labour and D labour labelled
• FIRST intersection of Maximum price line with S labour is labelled Qs at x-axis and SECOND is labelled Qd
• Producer revenue Pe x Qe falls to Pc x Qs creating a DWL
• DWL is to the left pointing at social optimum point
• CS increases but PS falls

Question 3

State 1 reason why price ceilings are enacted

Answer 3

• To Increase affordability of necessity goods or services thus, protecting the consumer from higher prices.

Question 4

Outline for who the govts. enact price ceilings and on what

Answer 4

Govts. May decide that the free market price is too high especially for low-income households that can’t afford more expensive alternatives
* Thus, price ceilings are enacted on staple foods like rice and bread described as necessities for them.

Question 5

Explain the stakeholder impacts after Price Ceilings are enacted (on govts, consumers, workers and producers)

Answer 5

• Govts: Neither gain nor lose govt. budget however they may gain political popularity among consumers that benefit from the price ceiling
• Consumers: Gain an area of CS from producers as they will be paying lower prices. However, lose an area of CS to DWL so Q1 to Q2 represents the consumers that are now not consuming the good
• Workers: Lose out because an extension in quantity of labour demanded, due to employers being more inclined to lower cost of labour, means lower wages
• Producers: Lose an area of PS due to DWL

Question 6

What consequence do price ceilings result in, why and is done to compensate for these consequences

Answer 6

• Price ceilings result in shortages due to the price mechanism no longer being able to achieve its rationing function therefore, insufficient quantity supplied can be distributed through non-price rationing methods like:
• First-come-first-served
• Favouritism
• Enforced Qualification criteria
  etc

Question 7

Explain what enforced qualification criteria is as a method of non-price rationing as a result of price ceilings

Answer 7

• For instance, income must not be less than $10k
• Without these, non-rationing methods may not guarantee that low-income earners will get the good ahead of high-income earners

Question 8

Explain how black markets can arise due to shortages and what govts. do in their response as a result of price ceilings

Answer 8

there will always be buyers willing to pay more and sellers equally willing to accept more hence, encouraging parallel markets to appear

• These illegal activities require policing which costs the government valuable resources due to them incurring opportunity costs

Question 9

Explain how underallocation of resources and allocative inefficiency arise from price ceilings

Answer 9

• Due to prices being lower than the equilibrium price, this results in smaller quantities supplied. This means there are too few resources allocated to the production of the good resulting in underproduction relative to the social optimum point thus, society is suffers as a result