Question

What is the effect of a price ceiling on the quantity demanded of the product? What is the effect of a price ceiling on the quantity supplied? Why exactly does a price ceiling cause a shortage?

Short answer

A price ceiling imposed below the equilibrium price leads to an increase in the quantity demanded and a decrease in the quantity supplied of the product. This discrepancy between demand and supply creates a shortage in the market, as the imposed price restriction prevents the market from reaching its natural equilibrium.

Step-by-step solution

Understanding Demand and Supply

The quantity demanded of a product is the number of units that buyers are willing and able to purchase at various prices. The law of demand states that, all else being equal, the quantity demanded of a good falls when the price of the good rises. The quantity supplied, on the other hand, is the number of units that producers are willing and able to sell at various prices. The law of supply states that, all other things being equal, the quantity supplied of a good rises when the price of the good rises.

Definition of a Price Ceiling

A price ceiling is a government-imposed maximum price that can be charged for a product or service. It is a policy decision that aims to keep prices affordable for consumers, especially for essential goods. However, it has some consequences on the market dynamics.

Effect of a Price Ceiling on Quantity Demanded

When a price ceiling is imposed below the equilibrium price, the market price cannot go higher than the imposed price ceiling. As a result, the quantity demanded of the product increases at the lower price, according to the law of demand.

Effect of a Price Ceiling on Quantity Supplied

Since the market price cannot go higher than the price ceiling, producers might be less willing and less able to supply the same quantity as before. This is because the imposed price might not cover their production costs or provide them with an adequate profit margin. Thus, the quantity supplied at the price ceiling is lower than the quantity supplied at the initial equilibrium.

Explaining the Shortage

A shortage occurs when the quantity demanded of a product exceeds the quantity supplied. In the case of a price ceiling, the imposed lower price leads to an increase in quantity demanded and a decrease in quantity supplied. As a result, there is an excess demand for the product and a shortage in the market. This happens because the market cannot reach its natural equilibrium due to the imposed price restriction. In summary, a price ceiling causes a shortage because it leads to an increase in the quantity demanded and a decrease in the quantity supplied of the product, resulting in a discrepancy between the two.