Question

Why does it matter if people can or cannot short-sell shares?

Answer 1

If people can short sell they can take a call on falling prices of the stock and they can hedge their portfolio which same level of stocks which they hold. The short selling provides perfect delta hedging. Short selling can be done if trader thinks, if a particular stock may fall in future, in such case short selling is beneficial for those traders.

When short selling is disallowed then investors or traders are denied from taking a benefit of short position in times of high volatility. Disallowing short selling is done with a purpose to protect the interest of overall market, in times of bad market everyone taking short position would worsen the condition of market and lot of investors would lose significant portion of investment in such rally.