Question

4.7. Explain in your own words what the effects will be on prices and quantities, if any, when government sets a maximum price above the equilibrium price and when a maximum price is set below the equilibrium price.

Answer 1

A maximum price happens when a state sets a legal cap on the price of a good or service in order to lower rates below the equilibrium price of the economy. The government may, for instance, set a maximum bread price of £ 1 –or a maximum weekly rent price of £ 150.

If the maximum price is set above the equilibrium price then it will have no effect.

If the maximum price is set below the equilibrium price, it will cause a shortage – demand will be greater than supply.

The government makes a normative judgment that the market clearing price is too large and needs to be lowered. For a multitude of reasons, the government can impose a maximum cost.

The good is vital for everyday living–some individuals may not be able to afford the good without a maximum cost. It can assist to decrease comparative poverty by lowering the cost.
Operation of the monopoly. If companies have monopoly authority, they can charge customers high rates–higher than the manufacturing marginal price and greater than in a competitive industry. A maximum price can be a way to reduce' monopoly rates' and boost the effectiveness of allocations.