Skip to main content

Price and Quantity controls: Price Ceiling

Governments can decide that market prices are unjust, markets may not allocate goods and services to those in need. When this is the case, governments may put  price and quantity controls on the market. In this post we will explore the practice of price ceiling.

A price ceiling is a maximum price that both producers and consumers are not allowed to exceed. This practice is used when a government thinks that a market price is excessive.

In a competitive market , if a government decides to impose a binding price ceiling (i.e: the new imposed price is smaller than the original equilibrium price), it results in the quantity demanded being greater than the quantity supplied. The market is unable to provide a good or service to every consumer willing to buy the product at the new given price, this results in a shortage. The shortage is represented by the difference between the quantity demanded and the quantity supplied at the new imposed price in the market.

Real life examples of price ceilings can be found in rent controls in California or in New York City. In India, a price ceiling was imposed on the ride sharing app Uber.


Example:



The government decides to put in place rent control in the real estate market. Assuming that this market is competitive, then the new binding price (PC) causes the quantity demanded to be greater than the quantity supplied. This results in a shortage in the market. The amount of people who are able to get a place to rent is lower (QS) then the quantity demanded (QD). Furthermore, the amount of real-estates supplied in the market is now lower than it was before the price ceiling (QS<QE). 


Reference: Mayer,David. AP Microeconomics Crash Course. Research & Education Association (2014). p 63.

Comments

Popular posts from this blog

Macroeconomics: multiplier and crowding out effects

Multiplier effect: whenever   any of the components of AD increases, the increase in GDP will be greater than the initial increase in expenditures. The impact on GDP of a particular increase in spending depends on the proportion of the new income that is taken out of the system to the proportion that continues to circulate in the economy. The multiplier effect tells us the impact a particular change in one the components of AD will have on the total income (GDP).  Let k denote the spending multiplier, which is a function of MPC and MPS. The larger the marginal propensity to consume, the larger the spending multiplier. Notice that the larger the MPC, the greater the impact a particular change in the spending variables will have on the nation's GDP. The crowding out effect: If government spending increases without an increase in taxes, the government must borrow funds from the private sector to finance its deficit, thereby increasing the interest rate. This increase in interest ...

Exercise: inflation and GDP deflator

You have the following table containing information about country Y's GDP deflator, nominal, and real GDP. If the base year is 2015, fill in the blanks and then find the annual inflation rate for each year. Year  Nominal GDP  GDP Deflator  Real GDP 2015 $23,457 100 $23,457 2016 $25,752 ... $23,943 2017 $25,982 108.1 ... 2018 $26,016 ... $25,431.1 2019 $26,323 105.5 ... Solution: Year  Nominal GDP  GDP Deflator  Real GDP   Inflation rate 2015 $23,457 100 $23,457 n.a 2016 $25,752 107.6 $23,943 7.6% 2017 $25,982 108.1 $24,035.2 0.45% 2018 $26,016 102.3 $25,431.1 -5.37% 2019 $26,323 105.5 $24,950.6 3.13%  GDP deflator for the year 2018: Real GDP for the year 2017: General formula to find real GDP by re-arranging the GDP deflator formula: Notice that the sub-index i is for the year. The (annual) inflation rate is simply the growth rate of prices from a year to its previous year: Inflation rate of the year 2018: Notice that in 2018 country Y experienced...

Microeconomics: Factor Markets

Definition: Factor markets: markets for the factors of production (example: labor and capital). Markets are formed whenever consumers and producers meet to exchange goods or services. Deriving factor demand: the demand for goods or services in the product markets creates demand for the factors of production.  An increase (decrease) in demand for good X leads the suppliers to increase their production thereby increasing (decreasing) the demand for the factors of production.   Marginal revenue product: The demand for the factor of production is formed by multiplying a firm's marginal revenue by its marginal product.  Remember that by taking the derivative of the TR function with respect to Q we are able to find the MR. Marginal product on the other hand is found by taking the derivative of the production function with respect to a factor of production (L or K for example). Marginal revenue product (MRP): the change in total revenue when one more input is employed. It decrea...