Question

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Define price ceiling and price floor and give an example of each. Which leads to a shortage? Which leads to a surplus? Why?

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Answer 1

The price ceiling is the act of fixing a maximum price or rate at which the commodity or service in the market can be sold. This is usually set by the market monitoring authority. An effective price ceiling leads to the creation of a shortage because it is set at the level lower than the equilibrium price. At a lower price, suppliers are willing to supply less but the demand increases at a higher price.

The price floor is the act of fixing a minimum price or rate at which the commodity or service in the market can be sold. This is also set by the market monitoring authority. An effective price floor leads to the creation of a surplus because it is set at the level higher than the equilibrium price. At a higher price, suppliers are willing to supply more but the demand falls short at a higher price.