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IAI Actuarial Core Principles · Business Economics · How competitive markets operate

In a competitive market for wheat flour, the government imposes a binding price ceiling set below the equilibrium price. Which outcome follows in the short run?

A binding price ceiling set below equilibrium creates excess demand, a shortage. At the lower price consumers want more than producers are willing to supply, and the quantity actually traded falls below the free-market level because it is limited by supply.

  1. AExcess demand (a shortage) at the ceiling priceCorrect
  2. BExcess supply (a surplus) at the ceiling price
  3. CEquilibrium quantity rises above the free-market level
  4. DProducer surplus increases because of higher sales volumes
  5. No change in quantity traded because price is fixed

Explanation

A ceiling below equilibrium lowers the price producers receive, so quantity supplied falls while quantity demanded rises. The gap is excess demand. Quantity traded is limited to the lower supply, so it falls below the free-market level and producer surplus declines.

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