Chapter 3: Problem 10

Does a price ceiling increase or decrease the number of transactions in a market? Why? What about a price floor?

Short Answer

Expert verified

A price ceiling generally decreases the number of transactions in a market, as it creates a shortage in the supply of the good or service. Similarly, a price floor also decreases the number of transactions, as it creates a surplus in the market. In both cases, these price controls distort the market equilibrium, leading to inefficiency and fewer transactions than what would have occurred in a free market without such controls.

Step by step solution

Understand Price Ceilings and Price Floors

Price controls are government interventions in the market to set a maximum (price ceiling) or the minimum (price floor) price for a specific good or service. A price ceiling is a legally established maximum price that sellers can charge for a good or service. It is usually set below the equilibrium price, which is the price at which the quantity of a good or service demanded by consumers equals the quantity supplied by producers. A price floor is a legally established minimum price at which a good or service can be sold. It is usually set above the equilibrium price.

Analyze the Effect of a Price Ceiling on Transaction Volume

To determine the effect of a price ceiling on the number of transactions, let's analyze a market with no price controls: at the equilibrium price, consumers' demand equals producers' supply, resulting in a certain number of transactions. If a price ceiling is implemented and set below the equilibrium price, the quantity demanded by consumers will increase (as the good or service becomes cheaper), but the quantity supplied by producers will decrease (as it may not be profitable for them to produce more at the lower price). This mismatch between demand and supply creates a shortage in the market, resulting in fewer transactions compared to the equilibrium level.

Analyze the Effect of a Price Floor on Transaction Volume

To determine the effect of a price floor on the number of transactions, let's again consider a market with no price controls: at the equilibrium price, consumers' demand equals producers' supply, resulting in a certain number of transactions. If a price floor is implemented and set above the equilibrium price, the quantity demanded by consumers will decrease (as the good or service becomes more expensive), but the quantity supplied by producers will increase (as it becomes more profitable for them to produce more at the higher price). This mismatch between demand and supply creates a surplus in the market, resulting in fewer transactions compared to the equilibrium level.

Conclusion

To answer the given exercise, a price ceiling generally decreases the number of transactions in a market, as it creates a shortage in the supply of the good or service. Similarly, a price floor also decreases the number of transactions, as it creates a surplus in the market. In both cases, these price controls distort the market equilibrium, leading to inefficiency and fewer transactions than what would have occurred in a free market without such controls.

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