Question

The demand and supply for bread in 18th century France are given by the following equations: P=20-Q (demand) & P=Q (supply)

A drought hits France and the rest of Europe, decreasing supply to P=4Q (steeper supply curve).   The French government is considering a price ceiling - a ceiling greater than or equal to $____ is irrelevant?

Answer 1

Equilibrium will occur in the market when Quantity demand = Quantity supplied.

Here demand is given by : P = 20 - Q => Q = 20 - P

Supply is given by : P = 4Q => Q = P/4 ------------------------New supply curve.

Thus Quantity demand = Quantity supplied => 20 - P = P/4

=> 5P/4 = 20

=> P = 16.

Hence, Equilibrium price = 16.

Price ceiling means that maximum price possible in the market is Price at which Price ceiling is set.

Suppose Price ceiling is set equal to or above Equilibrium price(= 16). Thus Maximum price possible in the market is this price ceiling price and is set set above or equal to equilibrium price.

If It is set above equilibrium price then there will be excess Supply. This results in decrease in price which leads to increase in quantity demand and decrease in quantity supplied and will reach equilibrium price of 16.

Thus If we set price ceiling above equilibrium price then price ceiling is not binding and Equilibrium price will prevail in the market i.e. Price ceiling is irrelevant.

Price ceiling means that maximum price possible in the market is Price at which Price ceiling is set.

Suppose Price ceiling is set below Equilibrium price(= 16). Thus Maximum price possible in the market is this price ceiling price and is set below equilibrium price.

If It is set below equilibrium price then there will be excess demand. But price cannot reach above price ceiling and equilibrium price = 16 > Price ceiling and hence equilibrium will never reach and hence Price at which price ceiling is set will prevail in the market.

Thus If we set price ceiling below equilibrium price then price ceiling is binding and price at which price ceiling is set will prevail in the market i.e. If we set price ceiling below equilibrium price then Price ceiling will be relevant.

Hence, The French government is considering a price ceiling - a ceiling greater than or equal to $16 is irrelevant.