Question

Does a price ceiling increase or decrease the number of transactions in a market? Why? What about a price floor?

Short answer

A price ceiling can decrease the number of transactions if it is set below the equilibrium price, as it results in increased demand but decreased supply, causing shortages. Conversely, a price floor can also decrease the number of transactions if it is set above the equilibrium price, as it leads to decreased demand but increased supply, resulting in surpluses. In both cases, the reduction in transactions occurs due to the mismatch of supply and demand caused by these price controls.

Step-by-step solution

Understanding Price Ceiling and Price Floor

A price ceiling is a government-imposed limit on the highest price that can be charged for a product or service within a market. On the other hand, a price floor is a government-imposed limit on the lowest price for a product or service. These price controls are usually placed to protect consumers from excessive prices or to maintain a certain income level for producers.

Effects of Price Ceiling on Number of Transactions

To analyze the effect of a price ceiling, let's consider two possible scenarios: 1. Price ceiling is above the market equilibrium price: In this case, the price ceiling will have no effect on the market since it allows suppliers to charge a price that already exists within the market. The number of transactions will remain unchanged. 2. Price ceiling is below the market equilibrium price: In this case, the maximum price that can be charged is lower than the equilibrium price. This lower price will encourage more consumers to buy the product, increasing the demand. However, the reduced price also discourages suppliers from producing more, decreasing the supply. Due to this mismatch between supply and demand, the number of transactions might decrease as shortages can occur. These shortages happen because suppliers are unable to meet the increased demand at the lower price.

Effects of Price Floor on Number of Transactions

To analyze the effect of a price floor, let's also consider two possible scenarios: 1. Price floor is below the market equilibrium price: In this case, the price floor will have no effect on the market since it allows suppliers to charge a price that already exists within the market. The number of transactions will remain unchanged. 2. Price floor is above the market equilibrium price: In this case, the minimum price that can be charged is higher than the equilibrium price. This higher price will discourage consumers from buying the product, leading to a decrease in demand. However, the increased price incentivizes suppliers to produce more, thus increasing the supply. Due to the mismatch between supply and demand, the number of transactions might decrease as surpluses occur. These surpluses happen because there isn't enough demand for the increased supply at the higher price. In conclusion, a price ceiling might decrease the number of transactions if it is set below the equilibrium price, while a price floor might decrease the number of transactions if it is set above the equilibrium price. This reduction in transactions occurs due to the mismatch of supply and demand caused by these price controls, leading to shortages (in the case of a price ceiling) or surpluses (in the case of a price floor).