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IAI Actuarial Core Principles · Business Economics · Government intervention in a market

A state government fixes the maximum retail price of a staple cereal below the price at which the market would clear. Which outcome is the most likely in the market for that cereal?

A binding price ceiling set below the equilibrium price causes excess demand. Consumers want more than producers will supply at the capped price, so shortages, queues and black-market trading are likely. Excess supply is the result of a binding price floor above equilibrium, not a ceiling.

  1. AExcess demand, leading to shortages and possible queues or black-market tradingCorrect
  2. BExcess supply, leading to unsold stocks building up
  3. CA rise in the equilibrium price as producers expand output
  4. DNo change in quantity traded because the price is fixed
  5. A fall in demand as consumers switch to dearer substitutes

Explanation

A binding price ceiling is set below equilibrium. At that price quantity demanded exceeds quantity supplied, so there is excess demand. Shortages, rationing, queues and parallel markets follow. Excess supply arises with a binding floor, not a ceiling.

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