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 market equilibrium price, affects the quantity demanded and supplied of a product. It causes an increase in quantity demanded as consumers prefer the lower price, while the quantity supplied decreases as producers receive a lower incentive to supply the product. The market is unable to reach equilibrium due to the price ceiling, creating a shortage where the demand for the product exceeds its supply. This imbalance is caused by consumers seeking more of the product while producers are disincentivized to provide the desired quantity, ultimately resulting in a shortage.

Step-by-step solution

Define Price Ceiling

A price ceiling is a government-imposed limit on the maximum price that can be charged for a product or service. This is usually done to protect consumers from high prices when a market situation (such as insufficient supply, high demand, or other factors) would result in market prices being much higher.

Understand the Demand and Supply Model

The demand-supply model in economics helps to understand the relationship between the price of a product and the quantity demanded by consumers and the quantity supplied by producers. When the market is in equilibrium, the quantity demanded is equal to the quantity supplied, and the market-clearing price is established. This means that there is neither a surplus nor a shortage of goods in the market.

Effect of Price Ceiling on Quantity Demanded

When there is a price ceiling imposed, the price of the product is forced below the market equilibrium price, which impacts the quantity demanded. Since the price is artificially lowered, the quantity demanded increases as more consumers want to purchase the product at the lower price. This can be represented by the demand curve in the demand-supply model where a lower price leads to a higher quantity demanded.

Effect of Price Ceiling on Quantity Supplied

On the other hand, producers will face a lower incentive to supply the product as they receive a lower price for it. As a result, the quantity supplied decreases, which can be represented by the supply curve in the demand-supply model where a lower price leads to a lower quantity supplied.

Explaining Shortages Due to Price Ceilings

A price ceiling causes a shortage because the market is unable to reach an equilibrium level. When the imposed price ceiling is below the market equilibrium price, the quantity demanded exceeds the quantity supplied. This situation leads to a shortage as the increased demand for the good cannot be matched by the available supply of the good. The lower price causes consumers to want more of the product, but it also disincentivizes producers from providing the desired quantity due to reduced profits. This imbalance in the market ultimately results in a shortage of the product. To summarize, a price ceiling impacts both the quantity demanded and the quantity supplied – it leads to an increase in quantity demanded and a decrease in quantity supplied. The price ceiling prevents the market from achieving equilibrium, which results in a shortage of the product.