Question

With the aid of supply and demand diagrams demonstrate that any and all effective price controls in a competitive market will reduce the actual quantity that can be traded (i.e. bought and sold) in that market.

 

SOME CLARIFYING COMMENTS FOR YOUR CONSIDERATION AS YOU WORK ON THIS ASSIGNMENT:

1. Note that an effective price control is one which forces a market to trade at a price that is different from the equilibrium price; thus an effective price control would be either a price ceiling below the equilibrium price, or else a price floors above the equilibrium price.

2. The key issue here is that nothing can be bought unless someone is willing to sell it, and nothing can be sold unless someone is willing to buy it. You can consider this in the context of diagrams such as the ones on pages 132 and 148 in the text.

 

please explain in details this. i am not sure where to begin in answering question. need assistance.

Answer 1

Effective price control refers to those regulations of government imposed in a market on price which either reduces or increases the equilibrium price.

The equilibrium price is the market clearing price of a market where demand and supply meets.

Price controls could be either price ceiling or price flooring.

Under price ceiling, a government imposed a price (usually lower than equilibrium price) above which no seller can produce. Consider the following graph -

In the above figure, Qe is the equilibirum quantity which occurs when there is no price control and P is the equilibrium price. Now notice that P1 is the price ceiling which is imposed by government, above which no seller can produce.Thus, now new price in market is P1. At this price demand is Qd but supply is Qs. consumers cant get Qd until sellers are ready to sell Qd at P1. Thus, the quantity that will be traded at P1 (ceiling price) will be Qs which is lesser than Qe.

Now, let's consider second case. Another price control is price flooring. Under price flooring, government impose a price in a market, below which no seller can sell. Consider the following graph,

As you can see, without price floor, the equilibrium quantity was Qe at price P. Now when price floor was imposed, demand is at Qd and supply is at Qs. seller can only sell upto the output which is demanded thus under price control, quantity traded is Qd which is less than Qe.

Price Floor Qd Qe Qs