Question

Many of the proponents of price ceilings argue that government-mandated maximum prices simply reduce producers' profits and do not affect the quantity supplied of a good on the market. What must the supply curve look like if the price ceiling does not affect the quantity supplied?

Short answer

If a price ceiling does not affect the quantity supplied of a good, the supply curve must be perfectly inelastic, i.e., a vertical straight line.

Step-by-step solution

Understanding the concept of price ceiling

When a price ceiling is set, it means a limit is placed on how high a price can be charged for a product. This is typically employed by governments to keep prices affordable for consumers.

Understanding the relationship between price and quantity supplied

If we consider the law of supply in economics, it states that as the price of a good increases, the quantity supplied also increases, assuming nothing else changes (ceteris paribus). This generally leads to an upward sloping supply curve.

Analyzing the impact of price ceiling on quantity supplied

If a price ceiling does not affect the quantity supplied, it implies that the quantity supplied remains the same regardless of changes in the price. This means that the quantity supplied is inelastic to the price. Inelastic supply occurs when the quantity supplied does not respond significantly to changes in price.

Determining the shape of the supply curve

If the quantity supplied is inelastic to price, the supply curve would be a vertical straight line. This is because, regardless of the price level, the quantity supplied remains the same.

Key concepts

Law of Supply

The law of supply is a fundamental principle in economics that describes the relationship between the price of a good or service and the amount of that good or service that suppliers are willing to produce and sell. According to this law, if all other factors remain constant (ceteris paribus), an increase in the price of a good or service will typically result in an increase in the quantity supplied. Conversely, a decrease in the price of a good or service will typically result in a decrease in the quantity supplied.

This relationship is represented graphically by the supply curve, which is characteristically upward-sloping. Suppliers are motivated to produce more because they can achieve higher revenues when prices are increased. This simple yet fundamental economic theory helps explain producers' behavior in the market under normal circumstances. For instance, in the agricultural sector, farmers may plant more crops if they expect higher returns due to increased market prices.

Quantity Supplied

The term 'quantity supplied' refers to the specific amount of goods or services that producers are willing and able to sell at a particular price during a certain time period. It's a snapshot of supply at one particular point on the supply curve. When the price of a good changes, the quantity supplied can also change; this is depicted by moving along the supply curve.

In the context of a price ceiling, if a government sets a maximum price below the equilibrium market price, it often results in a decrease in the quantity supplied—because producers may not be willing to sell their goods at a lower profit margin. However, if the exercise suggests a scenario where the quantity supplied does not change with the implementation of a price ceiling, this would indicate a perfectly inelastic supply, a unique and theoretical situation that is rare in real markets. In real-world scenarios, price ceilings often lead to shortages because the quantity supplied at the ceiling price is typically less than the quantity demanded.

Inelastic Supply

Inelastic supply, as the name suggests, refers to a situation where the quantity supplied of a good is not significantly responsive to the price changes. When supply is perfectly inelastic, it is depicted as a vertical line on a supply and demand graph, indicating that the quantity supplied remains constant no matter how much the price may rise or fall.

In reality, few goods have a perfectly inelastic supply. However, some goods have relatively inelastic supply due to factors such as production constraints, limited resources, or regulations. These goods won't see much change in the quantity supplied, even with significant fluctuations in price. In these markets, suppliers cannot easily ramp up production in response to price increases or are unwilling to decrease production when prices fall. Examples might include essential pharmaceuticals for which there are no substitutes, or unique resources with limited availability such as diamonds or certain rare minerals.