Question

Suppose the equilibrium price set by supply and demand is lower than the price ceiling set by the government. The eventual result will be a. a shortage. b. that quantity demanded is equal to quantity supplied. c. a surplus. d. a black market.

Short answer

In the given scenario, the equilibrium price is lower than the price ceiling set by the government. Since the market is allowed to function without constraint, it will naturally reach its equilibrium, where quantity demanded is equal to quantity supplied. Therefore, the eventual result will be: b. that quantity demanded is equal to quantity supplied.

Step-by-step solution

Understanding the Equilibrium Price

Equilibrium price is the price at which the quantity demanded by consumers is equal to the quantity supplied by producers. In other words, it's the price where the market is in balance, and there are no shortages or surpluses of goods.

Understanding the Price Ceiling

A price ceiling is a maximum price set by the government that sellers are allowed to charge for a good or service. Price ceilings aim to protect consumers from high prices by establishing an upper limit on the price of a certain product.

Effects of a Price Ceiling lower than the Equilibrium Price

If a price ceiling is lower than the equilibrium price, the quantity demanded will be greater than the quantity supplied, leading to a shortage of goods in the market.

Effects of a Price Ceiling higher than the Equilibrium Price

If a price ceiling is higher than the equilibrium price, the ceiling has no effect on the market, as it already allows the market to function without constraint. In such a case, the market will reach the equilibrium on its own.

Determine the Result of the Given Scenario

In the given exercise, the equilibrium price is lower than the price ceiling set by the government. This means that the market will gravitate toward the equilibrium price and function without constraint. As a result, the quantity demanded will be equal to the quantity supplied, and there will be no shortages or surpluses in the market. So, the correct answer is: b. that quantity demanded is equal to quantity supplied.

Key concepts

Equilibrium Price

The equilibrium price, often referred to as the market clearing price, plays a crucial role in economics. It's where the amount of goods or services that consumers want to buy (demand) is equal to the amount of goods or services the market can offer (supply). Imagine a seesaw perfectly balanced with supply on one side and demand on the other; the equilibrium price is the point where the seesaw doesn't tip either way.

This balance ensures that the resources are allocated efficiently. Prices above the equilibrium point will leave unsold goods, creating a surplus. Conversely, prices below this point can lead to too many buyers chasing too few goods, causing a shortage. In our problem scenario, because the price ceiling set by the government doesn't interfere with the equilibrium price, neither surplus nor shortage occurs, and the market operates smoothly, matching supply with demand.

Supply and Demand

Supply and demand are arguably the most fundamental concepts of economics and they are the backbone of a market economy. Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the higher the price, the lower the quantity demanded, and vice versa.

Supply represents how much the market can offer. The quantity supplied refers to the amount of certain goods producers are willing to supply when receiving a certain price. The direct relationship between price and quantity supplied is known as the law of supply: as the price increases, so does the quantity supplied.

Market equilibrium is achieved when the quantity demanded is equal to the quantity supplied. When a price ceiling doesn't disrupt this balance, as it is in our scenario, buyers and sellers reach agreement, and the market operates effectively without excess or shortage.

Market Shortage

A market shortage occurs when the demand for a product exceeds the supply available at the current price. Shortages typically happen when there's a disconnect between consumer desires and the availability of goods, often aggravated by pricing constraints. If we reverse our problem's circumstances and the price ceiling were set below the equilibrium price, it would be illegal for the price to rise to the market-clearing level. Buyers would want more at the price ceiling than sellers would be willing to offer, leading to a shortage.

In such cases, the shortage can result in consumers competing for scarce goods, possibly creating black markets where goods are sold illegally at higher prices. Long-term shortages can push the market to find a new balance at an even higher price than the previous equilibrium if the ceiling is lifted. Fortunately, in our problem, because the price ceiling is above the equilibrium price, the scenario avoids a shortage and allows the market to adjust naturally.

Government Intervention in Markets

Governments intervene in markets primarily to correct market failures and to achieve a more equitable distribution of income and wealth. They might set price ceilings, like in the scenario we're discussing, to help lower-income consumers afford essential commodities during periods of inflation or scarcity.

However, government intervention can also lead to unintended consequences. For example, a price ceiling set below the equilibrium price can lead to shortages, market inefficiency, and sometimes even worsen the welfare of the people it was designed to help. In cases where the price ceiling is set above equilibrium, market forces prevail as seen in our exercise, and the intervention doesn't distort the market outcome. This understanding is vital as it helps balance the objective of protecting consumers with the need to maintain an efficient market system.