Question

Consider the following scenario - government policy sets a fixed/universal price for wheat at $5 per bushel. In the absence of this policy, the market equilibrium price for wheat (i.e., the price where Quantity Demanded equals Quantity Supplied) is $6 per bushel. Given these market conditions, explain the economic consequences of this price policy. Be sure to draw a graph as part of your answer!

Answer 1

Given the market conditions as the demand curve (D) and supply curve (S) of wheat intersect each other at the point of equilibrium and hence the equilibrium Price=$6 and quantity =3 bushels.

Now suppose a government policy sets a fixed/universal price for wheat at $5 per bushel. This can be shown in the graph as-

From the figure it can be seen that the government price is below the equilibrium price and hence at this price supply of wheat is less than what it was before (2.5<3) but the demand is higher than before(3.75>3). So there is a shortage of wheat in the market. This is because at lower prices the profit is also low and hence the firms supply less output and hence the overall supply will decrease.