Question

Well-meaning individuals sometimes argue that the government should cap the price of food or energy to ensure that it is affordable for everyone. At this point, you should be able to explain in some detail why economists believe that this policy usually is a bad idea. Briefly do so.

Answer 1

The practice of capping the price of a good or a service is called price ceiling. When there is no price ceiling, government is at equilibrium, with quantity Q and price P. But when the price ceiling of P' is imposed, which is less than P, then quantity demanded in the market increases to Qd but quantity supplied falls to Qs. This creates a situation of shortage of the good in the market. So, people whi are willing to pay the market price for the good are not able to get the good or are facing difficulties to purchase the good, so, this creates an inefficient allocation of the good in market. This ineffeciency in the market can be seen by the deadweight loss triangle shown by the shaded area in the figure.

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