Question

Short Answer (10 points total) On January 29, 2020, Sri Lanka's drug regulatory agency announced that it would put price controls on face masks. Before this announcement, face masks were selling at prices 10 to 20 times the normal price. a. (2 points) Why might the price of face masks be rising so quickly in Sri Lanka? (For full credit, provide both an intuitive explanation and an explanation that uses the supply and demand model. You may write your answer in words or illustrate with a correctly-labelled model.) b. (2 points) Why might the government want to use price controls in this situation? What type of price control should it use? C. (4 points) What is the trade-off of using price controls in this situation? That is, what might happen in the economy as a result? (For full credit, discuss changes to quantity, total economic surplus, and any other positive or negative consequences of the price control. You may write your answer in words or illustrate with a correctly-labelled model.)! (2 points) Given the trade-offs, do you think the Sri Lankan drug regulatory agency is making the right decision? Why or why not?

Answer 1

a) The price and quantity is the function of supply and demand in the market. The demand is a downward sloping curve and supply is upward sloping. It means at a higher price the demand will be lower but supply will be higher. However, if any event suddenly increases the demand then the demand curve will shift to the right and equilibrium price will go up to the point where there will be no excess demand for the available price and quantity.

b) The higher price might also be the result of collusion by the suppliers in the market and this is the case of market failure. The government should intervene in the case of market failure or when that commodity is essential in nature.
The government can impose a price ceiling as a price control measure. In this case, the government set up a maximum price sellers can charge for the product.

c) The price ceiling is very a popular and easy measure the government can adopt. However, it is not effective. A price ceiling is the maximum price the sellers can charge for a product and it is imposed in case of unusually high price of that product. The price ceiling is set below the equilibrium price level because it will not serve any purpose if it is set above the equilibrium level. The lower than the equilibrium price means there will be a lower supply in the market.
The supply will be well below the demand and there will be a shortage in the market. The effect of this is the development of black market of the same product.

d) The price control through imposition of the price ceiling will create a shortage of that product in the market and will also enable the black market for that. So the decision by the Sri Lankan drug regulator is not quite right or we could say will be ineffective. It should have explored import from the international market.