Price Ceiling : A price ceiling is the maximum price of a product set by the Government or Law. It is usually set when the market price of that product, usually a necessary good, goes way above the usual level. Now it is understandable that when prices are set lower than the market price level there will be shortages because that quantity demanded will be higher than the quantity supplied. We will discuss this in detail in the following solved questions.
Price Floor : This is exactly the opposite to price ceilings. This is the minimum price that has to be paid for a particular product. So Government or law set a specific price which is above the market price for that product. This creates surplus as the quantity supplied is higher than quantity demanded at the price floor.
Let’s solve some questions to clear the concepts further.
Look at price floor set at 10 there is an excess supply of labour(surplus) which is the difference between 310 & 210. This excess labour will be unemployed.
At a minimum wage 8, demand for labour is standing at 25. So firms are willing to hire 25 workers. Notice since the supply is greater than the demand there is a surplus which is arising due to price floor.
At price ceiling of $10, supply of the goods is standing at 270 units. So consumers are able to buy 270 units of the product. Note that at price 10 the demand is actually 310 units however, due to price ceiling there is a shortage in supply and hence, consumers will be able to buy only 270 units.
Binding price ceiling is set at lower than equilibrium price. Hence, quantity demanded will be higher than supply creating a shortage.
This question is easily understandable from the diagram itself. Pd is the price buyer are willing to pay. At ps quantity supplied is Qs (see the supply curve) and quantity demanded is Qd (see the demand curve).
Price floors create surpluses as as the quantity supplied is higher than quantity demanded at the price floor. Price ceiling creates all the other three impacts. The difference between what buyers can pay and what sellers are charging encourages buyers to line up for buying that product which is considered as wasted time. Price controls always reduce the gains from trade. Price controls also distort market signals and eliminate signals which cause misallocation of resources.
Whenever the price is closer to market clearing level the impact of price control is lesser which means the loss of gains of trade will also be lesser. Hence, option B is the correct option.
When demand is greater than supply it creates shortage. See that at price=10 the shortage equals to 20-5=15.
A binding price floor occurs when the government sets a required price on a good or goods at a price above equilibrium or market price. So option b panel b. is the correct option.