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 is a government-imposed limit on the maximum price of a product. This regulation, usually set below the market equilibrium price, aims to make goods more affordable for consumers. The law of demand states that when the price decreases, the quantity demanded by consumers will increase. When a price ceiling is imposed, it leads to an increase in the quantity demanded. However, at the lower price, producers are less willing to supply the product due to lower profitability, causing the quantity supplied to decrease. This imbalance between the increased quantity demanded and decreased quantity supplied results in a shortage in the market.

Step-by-step solution

Define Price Ceiling

A price ceiling is a government-imposed limit on how high a price can be charged for a product. This regulation is usually set below the market equilibrium price in an attempt to make goods and services more affordable for consumers.

Explain the Law of Demand

The law of demand states that when the price of a product decreases, the quantity demanded by consumers will increase, and vice versa. In other words, there is an inverse relationship between the price and the quantity demanded.

Explain the Law of Supply

The law of supply states that when the price of a product increases, the quantity supplied by producers will also increase, and vice versa. In other words, there is a direct relationship between the price and the quantity supplied.

Effect of Price Ceiling on Quantity Demanded

When a price ceiling is imposed, it sets a maximum price for the good or service lower than the market equilibrium price. At this lower price, more consumers are willing and able to purchase the product, leading to an increase in the quantity demanded according to the law of demand.

Effect of Price Ceiling on Quantity Supplied

However, at the lower price caused by the price ceiling, producers are less willing to supply the product because their costs may not be covered, and they may seek to produce and sell a different product with higher profits. According to the law of supply, the quantity supplied of the product will decrease.

Price Ceiling Causes a Shortage

A price ceiling causes a shortage in the market because the quantity demanded by consumers exceeds the quantity supplied by producers. At the lower price created by the price ceiling, consumers want to consume more of the product and producers want to supply less, resulting in an imbalance between supply and demand. This mismatch creates the shortage.