Question

Which statement is true? (LO5, 6) a) A price floor is above equilibrium price and causes surpluses. b) A price floor is above equilibrium price and causes shortages. c) A price floor is below equilibrium price and causes surpluses. d) A price floor is below equilibrium price and causes shortages.

Short answer

The correct statement is: a) A price floor is above equilibrium price and causes surpluses.

Step-by-step solution

Recall the definition of a price floor

A price floor is a government-imposed minimum price that can be charged for a good or service in a market. It's meant to prevent prices from falling below a certain level, often to protect producers, but can cause market imbalances if placed above or below the equilibrium price.

Analyze the relation between price floor and equilibrium price

A price floor can be set either above or below the equilibrium price. If it's set above the equilibrium price, it forces the price in the market to be higher than the price at which demand and supply are equal. In this scenario, the supply of the good or service is greater than the demand, leading to a surplus. Conversely, if a price floor is set below the equilibrium price, it doesn't affect the market, as market participants are willing to transact at a price higher than the floor; thus, the market will still reach equilibrium.

Evaluate the statements

a) A price floor is above equilibrium price and causes surpluses: This statement is true. When the price floor is set above the equilibrium price, suppliers supply more than the quantity demanded, leading to a surplus of the good or service. b) A price floor is above equilibrium price and causes shortages: This statement is false. When a price floor is above the equilibrium price, it causes a surplus, not a shortage. c) A price floor is below equilibrium price and causes surpluses: This statement is false. When a price floor is set below the equilibrium price, it does not affect the market, and the market still reaches equilibrium. d) A price floor is below equilibrium price and causes shortages: This statement is false. When a price floor is set below the equilibrium price, it does not affect the market, and there will be no shortages or surpluses.

Conclusion

Among the given statements, the true one is: a) A price floor is above equilibrium price and causes surpluses.

Key concepts

Equilibrium Price

The equilibrium price is where the quantity of goods supplied equals the quantity demanded by consumers. Imagine a busy marketplace bustling with buyers and sellers. At this magical point, everyone is happy because suppliers can sell all their products, and consumers get what they want without any leftover stock or unfulfilled demand.
This balance occurs naturally, without any distortions. Supply and demand curves in a graph typically intersect at this point. This intersection determines the equilibrium price, which is the most efficient state for the market. It is perfect harmony where resources are allocated optimally.

• Equilibrium avoids shortages and surpluses.
• Adjustments in price help maintain equilibrium.

Disruptions, like government interventions, can move the market away from this balance, causing inefficiencies and potential imbalances.

Market Imbalance

Market imbalance arises when supply and demand are not aligned. Think of it as a seesaw that tips when there is too much or too little of something. Imbalances can occur for several reasons, like abrupt changes in consumer preferences or supply disruptions.
One common cause of imbalance is the implementation of policies like price floors. When a price floor, a minimum legal price, is set above the equilibrium level, it forces prices artificially higher than they would naturally be.

• Price floors can lead to excess supply, creating a surplus.
• Price ceilings, the opposite, can cause shortages.

To regain balance, markets may need adjustments in production or consumption patterns. Sometimes, government intervention could correct itself, but often it persists, leading to continued inefficiency.

Surplus and Shortage

Surpluses and shortages illustrate market inequalities. Picture a bakery. A surplus occurs when they bake more bread than customers want to buy, leading to excess goods. This is common with a price floor set above equilibrium, as it encourages more production but less consumption.
On the flip side, a shortage happens when the bakery cannot produce enough to meet customer demand. However, price floors generally do not cause shortages, since they elevate the minimum price, deterring customers rather than encouraging excess demand.

• Surplus: excess production due to high prices.
• Shortage: unmet demand often due to low prices.

Learning about surpluses and shortages helps in understanding market dynamics and the unintended effects of interventions such as price floors. Awareness of these concepts can guide better policy decisions and promote market health.