Question

Suppose the market for tomatoes is in equilibrium, and events occur that simultaneously shift both the demand and supply curves to the right. Is it possible to determine how the equilibrium price and/or quantity would change? Explain. Why does an effective price ceiling appear below the equilibrium price rather than above it?

Why does an effective price ceiling appear below the equilibrium price rather than above it?

Answer 1

(a) When demand curve shifts right, price increases and quantity increases. At the same time, when supply curve shifts right, price decreases and quantity increases. Therefore, as a net effect, quantity definitely increases, but effect on price is uncertain. Price will increase (decrease) if rightward shift in demand curve is higher (lower) in magnitude compared to the rightward shift in the supply curve.

(b) A price ceiling fixes an upper limit of the price, above which producers cannot charge. In order to be binding, the ceiling price has to be imposed below the equilibrium price, because if the market is clearing at equilibrium price, imposing a ceiling price at or above the equilibrium price will not impact the quantity demanded and quantity supplied, rendering the ceiling price as ineffective and meaningless.