Answer to Question #153299 in Microeconomics for Faisal

Question

Explain price ceiling and price flooring also analysed the effects of both actuon on market

Answer 1

ANSWER

A price ceiling is a government price control way that government sets the highest price that can be charged for a product (it is a way to protect the consumers/personals).

A price flooring is a government price control way that government sets the lowest price that can be charged for a product (it is a way to protect the suppliers/business entites).

Let's assume that an initial market state is the market equilibruim. According to this assumption we can find the market (equilibrium) quantity and the market (equilibrium) price using the following equation

Qd(Pe) = Qs(Pe), where Pe - is the equilibrium price, Qd is a demand function and Qs is a supply function.

If in this state the govermnent decides to use the price ceiling or price flooring, the market equilibrium will be destroyed. Hence, the consumer and producer surpluses will be changed too.

Let's denote the price that is used in the price celling strategy by PC and the price that is used in the price flooring strategy by PF.

1) Let's assume that $PF>Pe>PC$.

According to the demand and supply laws we can write the following inequalities:

$dQs/dP>0$ , hence the function of Qs with respect to the price is increasing.

$dQd/dP>0$ , hence the function of Qd with respect to the price is decreasing.

Then, the Qs when price is equal to PC is less than that of in the cases of Pe and PF.

Also it is necessary to underscore that the Qd when price is equal to PC is greater than that of in the cases of Pe and PF.

Hence, when P=PC (price ceiling strategy), the Qd is dramatically greater than Qs (the case named as excees demand). Company's storages are empty.

When P=PF (price flooring strategy), the Qd is dramatically less than Qs (overstoking).

2) Let's assume that $PC>Pe>PF$.

When P=PF (price flooring strategy), the highest demand is constrainted.

When P=PC (price celling strategy), the lowest supply is constrainted.