Suggested Answers of BT2 Revision Package - ASKnLearn

Explain causes ofan increase in priceExplain how a priceceiling prevents aprice increaseequilibrium price will increase to P E if the government does notintervene.However, as rice is a staple food, the government may wish to keepprices low so as to ensure it remains affordable the governmentimposes a price ceiling at price P MAX , preventing further price increases.At price P MAX , the quantity demanded of rice is Q units. But firms wouldonly be willing to supply quantity Q s of rice. Thus, a shortage of QQ s iscreated at P MAX .PriceS 1Figure 1Price CeilingP EP MAX =PMaximum PriceQShortage DQ EQ DD 1QuantityLink back toquestion.Define price floorExplain why thegovernmentimposes them,giving examples.Hence, the price ceiling prevents price from increasing beyond the levelset by the government. Any further increase in demand and or a fall insupply will not raise prices but will worsen the shortage instead.However, the shortages created by this policy would need to beaddressed by the government, either through an efficient rationingprocess, or by subsidizing producers to raise output.Price floor is the minimum price set by the government above themarket equilibrium price, which is deemed too low and to prevent anyfurther decline in price. Price floors are seen as a common tool for thegovernment to achieve a more equitable (fair) distribution of income.For example, to protect farmers from the loss of revenue when themarket prices for their agricultural products decline sharply, thegovernment may set a price floor on the agricultural products; similarly,minimum wage laws can be implemented help unskilled workers.Taking the example of the market for coffee beans. Referring to Figure2, the market is initially in equilibrium at price P and output Q. If thesupply of coffee falls to S 1 , equilibrium price will fall to P E if thegovernment does not intervene.