Question

Consider the market for some product X that is represented by the demand-and-supply diagram to the right. a. With an initial equilibrium at (p*Q*), if the government decides to impose a price ceiling equal to P1, the price p1 ------ the quantity exchanged and the market efficiency b. With an initial equilibrium at (p*,Q*), if the government decides to impose a price floor equal to P7, the price the quantity exchanged and the market efficiency Q* Qx

Answer 1

a. A price ceiling is only effective, it it is set below the equilibrium price level. Here, the equilibrium price level is below p₁, the price ceiling set by the government. So, it will have no impact on the market. Price and quantity will be same as in the equilibrium level without any intervention. Hence,

The price remains same at p^*

The quantity exchanged remains same at Q^*

The market efficiency does not change as the old equilibrium (without government intervention) price quantity combination remains unchanged.

b. if the government decides to impose price floor equal to p₁, the quantity demanded is lower than the quantity supplied at that price. This will create excess supply in the market. The quantity exchanged is the minimum of the quantity supplied and quantity demanded. Hence, quantity exchanged will be same as the quantity demanded. The market will face deadweight loss and hence, efficiency decreases.

The price is higher and set to p₁

The quantity exchanged decreases and is equal to the quantity demanded at price p₁

The market efficiency decreases due to deadweight loss.