Question

How does a price ceiling set below the equilibrium level affect quantity demanded and quantity supplied?

Short answer

A price ceiling set below the equilibrium level leads to an increase in quantity demanded and a decrease in quantity supplied, resulting in a market shortage, as the lower price makes the product more affordable for consumers but less profitable for producers to supply.

Step-by-step solution

1. Define a Price Ceiling and Equilibrium Level

A price ceiling is a government-imposed limit on how high a price can be charged for a product. Meanwhile, the equilibrium level (also known as market equilibrium) occurs when the quantity demanded by consumers equals the quantity supplied by producers at a particular price. It represents a balance between supply and demand in a market.

2. Understand the Market Situation without a Price Ceiling

Before analyzing the impact of a price ceiling, let's first understand the situation without one. In a free market, supply and demand forces determine the equilibrium price and quantity traded. At the equilibrium level, there is no excess supply or excess demand. We can represent this graphically, with price on the vertical axis and quantity on the(horizontal axis. The demand curve slopes downward, representing the inverse relationship between price and quantity demanded, while the supply curve slopes upward, representing the positive relationship between price and quantity supplied. The point of intersection between these curves is the equilibrium point.

3. Introduce a Price Ceiling below the Equilibrium Level

Now, we introduce a price ceiling below the equilibrium level. This means that the government sets a maximum price for the product that is lower than the market equilibrium price. In this situation, the price in the market cannot exceed the price ceiling.

4. Analyze the Impact on Quantity Demanded

With the price ceiling in place, the price of the product is lower than it would be in a free market. This makes the product more affordable for consumers. As a result, the quantity demanded will increase following the law of demand, which states that as the price of a product falls, the quantity demanded increases, ceteris paribus.

5. Analyze the Impact on Quantity Supplied

At the lower price created by the price ceiling, the quantity produced and supplied may decrease. This occurs because a lower price can make it less profitable for producers to produce the good. The law of supply states that as the price of a product falls, the quantity supplied will decrease, ceteris paribus.

6. Identify the Shortage Created in the Market

A price ceiling below the equilibrium level may result in a shortage in the market. The shortage occurs because the quantity demanded at the price ceiling exceeds the quantity supplied. In other words, there are more consumers wanting to buy the product at the lower price than producers willing to supply it. To summarize, when a price ceiling is set below the equilibrium level, the quantity demanded increases, and the quantity supplied decreases. This results in a shortage in the market, as the demand for the product at the lower price exceeds the available supply.