Price Equilibrium & Subsidies

Topics: Supply and demand, Economic equilibrium, Price floor Pages: 3 (1026 words) Published: February 16, 2011
Price ceiling create shortage. How to overcome it?

According to the book “Economic Theory in the Malaysian Context”, the definition of price ceiling is a legally established maximum price a seller can charge. It means that the price is lower than the equilibrium market price and it cannot go above the ceiling price. The reason that government imposes ceiling price on item such as beef, flour, sugar and many more is because to ensure that consumers are able to buy these goods at a reasonable price thus prevent sellers to sell the goods at a high price. The application of this type of price control is suitable to reduce inflation. I take the price of sugar per kg against the quantity of the sugar for an example. Before price ceiling is being applied, the equilibrium price in the market for sugar is RM2.50 per kg and the quantity of sugar that can be obtained is 7 kg per month per customer at point E. However, if the government thinks that the price is too high for consumer and then they will impose a ceiling price of RM1.20 per kg of sugar. At the price of RM1.20, it shows that there are larger quantity demanded of sugar than quantity supplied (Qd>Qs). From the figure, we can see that the demand quantity of sugar is 10 whereas quantity supplied is only 4. From this, we can see that a shortage of sugar supply exists. With a price ceiling, the tendency for the sugar’s price to rise to its own equilibrium cannot be fully realized because everyone is forbidden to trade at the equilibrium price. The result is an effective price ceiling may leads to a black market which the producers is willing to sold the price-controlled good at an illegally high price through various methods. To ensure that the black market does not appear, government can apply non-price rationing policy where the consumers will be forced to purchase a limited amount of the price-controlled goods. For example, recently, the Malaysian government had announced that consumers are...
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