Question

Governments are frequently tempted to introduce price ceilings in markets. Use an example to explain why this is not such a good idea, at least when markets are competitive. Give some ideas as to what the government could do instead in order to help consumers in these markets.

Answer 1

Ans. Suppose, government imposes a price ceiling of $Pc in the market below the market clearing price of $P. This, will lead to a quantity demanded of Qd and quantity supplied of Qs and Qs < Qd. So, there is a shortage of the good in the market. So, people who are willing to buy the good at market clearing price P are unable to buy that due to shortage creating deadweight loss represented by the shaded triangle. Thus, price ceiling is an inefficient outcome.

If government wants to reduce prices, it can make some pro-business rules which will increase the aupply if the good in the market decreaing the price level and increasing the equilibrium quantity in the market without creating any deadweight loss.

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