Question

A price ceiling will have the largest effect: a. substantially below the equilibrium price b. slightly below the equilibrium price c. substantially above the equilibrium price d. slightly above the equilibrium price

Short answer

The price ceiling will have the largest effect on the market when it is set substantially below the equilibrium price (option a). This scenario creates a significant gap between the quantity demanded and the quantity supplied, leading to shortages, market inefficiencies, and potential reduction in the quality of goods.

Step-by-step solution

1. Understanding the Price Ceiling

A price ceiling is a government-imposed limit on the maximum price that can be charged for a product or service in the market. The purpose of a price ceiling is to protect consumers from the potential exploitation by suppliers, especially during times of shortages or market crises. When a price ceiling is set, it prevents prices from rising above the established level. This policy can benefit some consumers by making goods more affordable, but it can also lead to negative consequences such as market inefficiencies, shortages, and reduced quality of goods.

2. Equilibrium Price

The equilibrium price, also known as the market-clearing price, is the price at which the quantity demanded by consumers equals the quantity supplied by producers. At this price level, there is no surplus or shortage of goods in the market, and both producers and consumers are satisfied with the quantity and price of the goods traded. The equilibrium price can be found by analyzing supply and demand curves, which illustrate the relationship between the quantity of goods and their respective prices.

3. Analyzing the Four Options

We need to analyze the possible effects of a price ceiling in each of the four given scenarios: a. Substantially below the equilibrium price: In this case, the price ceiling is set much lower than the current market equilibrium price. This would create a significant gap between the quantity of goods demanded by consumers and the quantity that suppliers are willing to supply at this low price. This leads to a shortage of goods and a significant market imbalance. b. Slightly below the equilibrium price: In this scenario, the price ceiling is set just below the market equilibrium price. There may still be a gap between the quantity demanded and the quantity supplied, but it will be smaller compared to a price ceiling substantially below the equilibrium price. The effect on the market is less severe compared to option (a), but there might still be shortages and market inefficiencies to some extent. c. Substantially above the equilibrium price: When the price ceiling is set much higher than the market equilibrium price, it is unlikely to have a significant impact on the existing market balance. Suppliers will continue to provide goods at the equilibrium price, as the high price ceiling has no effect on them. d. Slightly above the equilibrium price: Similarly to option (c), a price ceiling set slightly above the equilibrium price is unlikely to significantly affect the market. The price ceiling does not directly influence the prices suppliers are charging or the quantity consumers are demanding.

4. Largest Effect on the Market

Based on the analysis of the four options, a price ceiling will have the largest effect on the market when it is set substantially below the equilibrium price (option a). In this scenario, there will be a significant difference between the quantity demanded and the quantity supplied, leading to shortages, market inefficiencies, and potential reduction in the quality of goods.