Question

Question 3 (10 Marks) a) The government is currently considering setting a maximum price (price ceiling) for basic goods to ensure that people can get access to these goods at this current time. Fully explain your answer and also use a single diagram to demonstrate the likely outcomes of this policy if the maximum price is set:

1. Below the current free market price

2. Above the current free market price

3. At the current free market price

Answer 1

Bicep S P2 E 12 (Equilibrium price Po - Pi D S quantity

1. When maximum price is set below the current free market price, then it becomes binding or effective. Price ceiling is a type of government intervention where government sets the maximum price that a producer can charge. This policy is in favour of the consumers so that goods don't turn out to be too expensive. So when it is set below the equilibrium price, the policy is effective for the consumers. Here, P1 is the price set by the government. At this point, demand exceeds supply.

2. When price ceiling is set above the current free market price, the policy is ineffective for the consumers and intrun it will support the producers as the price is above the equilibrium price. Here, p2 isithe price set. At this price ceiling, supply exceeds demand. Hence, there is an excess supply.

3. When the price is set at current free market, the policy is non binding or ineffective. Here, price ceiling is at P0 which is the equilibrium price because of which the policy becomes ineffective as consumers will have to pay the market price which would be expensive. At this point, demand equals supply.