A ceiling of price happens at a time when a state puts in action a legal limit the height the price should reach for a given product. For an effective price ceiling, the latter should be set right beneath market equilibrium. A shortage arises automatically as soon as a price ceiling is set. There is more demand occurring than it should be at equilibrium price when a price ceiling is set. The supply also goes down when there is price ceiling than when it would be at equilibrium and hence quantity demanded increases. There is an inefficiency that is bound to come up since the marginal benefit is more than the marginal cost. This kind of inefficiency is equivalent to deadweight loss (Steven et al, 2013).
It has a price ceiling at 300$, that would represent the price that is set by the government. However, at price 700$, the marginal consumer wants to purchase at 3000, a quantity that the business is willing to supply the bicycles. A dead weight welfare loss comes about due to the fact that the marginal benefit is greater than the ceiling price. At the price 500$ and quantity 5000, we have the equilibrium. At price 300$ the quantity that is demanded is greater than the quantity which is supplied. The latter is the primary cause of the shortage. At the price of 300$, the demand for ten speed bicycles would be high but the business will not be in a position to supply the bicycles at that price (Steven et al, 2013).
Given that a price ceiling is set, there must always be a method that is used to know who gets the limited supply of the good produced. Due to the fact that there is a legal limit on the price, the given price can be changed (raised).There are a number of ways that can be adopted without necessarily raising the price (Steven et al, 2013).
Lottery: drawing names out of hat is one of the methods that can be done to distribute a product which is limited. Once one gets drawn, then they can try their luck by looking and shooting the moose in that duration of the season.
Black market: For the lucky ones who are capable of getting the limited supply, they are better off because they sell what they get to the consumers who will get the highest benefits out of the product.
Historical use: In some given times, a given state can allow the consumers of a certain good and who were ready to consume to continue with the consumption. The latter can prove to be hard to handle because after the ceiling, more people would come in and claim to be past members of the consuming lot. This will leave some historical consumers not satisfied (Steven et al, 2013).
The price binding in our case is binding since the price at equilibrium set higher than the ceiling price and the equilibrium price cannot be easily attainable. The supplier of the bicycles will not be motivated to supply many bicycles than the ones he supplied at the equilibrium because of the decrease in prices. The binding is effective since the consumers are willing to pay and are able but there is a shortage in supply (Steven et al, 2013).
A price floor refers to the lowest price that any given good can be legally sold at. They are commonly used by the governments to make sure that the prices are not too low. One of the scenarios which is faced by the price floor is the minimum wage rate (the lowest price that a labor can be paid).for the effectiveness of a price floor, it ought to be set above the equilibrium price. In a case where by the price floor is not set above the equilibrium, the markets are bound not to sell below equilibrium and this will make the price floor irrelevant. In our given case above, the price floor is supposed to be fixed at 700$.The price floor is hence said to be above the equilibrium price which according to our diagram is 500$.some other things start emerging when the price floor is set. First, the price floor has changed the price by rising above the equilibrium and hence the consumers are therefore not willing much of this quantity. The consumers will then purchase the commodity at the point where the quantity which is demanded forms an intersection with the price floor or else where the demand curve forms an intersection with the price floor. Since the price is higher than how it could at the equilibrium, the bicycle seller will supply the bicycles more than the equilibrium quantity (Isaac, 2014).
The price increase creates some problem in that there is a relatively less quantity of the bicycles that are demanded than the quantity that is supplied in the market. This is hence called surplus and they supply to the point when the trivial cost is equal to a point where supply curve forms an intersection with the price floor. Thereby, there will be a lesser quantity of bicycles demanded than the quantity of the bicycles supplied and this will create surplus. Given that the surplus bicycles will be allowed to remain in the market, the price is then bound to go down below the equilibrium level. To prevent this kind of a situation, the state can enter the market and opt to: buy all the surplus bicycles, put emphasis on the price floor and overlook the surplus, control the number of bicycles produced or subsidies consumption through paying some of the cost to attract more consumers (Isaac, 2014).
A deadweight loss for the welfare occurs when there is a difference that the consumer is able to pay compared to the cost at equilibrium. The deadweight loss refers to the loss of a consumer and the surplus generation. To be precise, any given regulation put in the market that will cause a movement in the market far from equilibrium, the transactions of benefit that could have taken place will then not occur. The difference between 7000$ and 3000$ is the loss incurred by the society for the case of a price floor (Isaac, 2014).
The government uses the price floor tool to regulate the prices. A price floor means that the cost of a commodity or any service is not supposed to go lower than the floor price. A least income law is a good case of price floor. The price floor given in our diagram is binding since it is higher than the equilibrium price. The cost floor given in our question is binding since the price for ten speed bicycles is above the equilibrium. The price floor causes disequilibrium in the market since it will exclude the consumers who are willing to by the bicycles at a price lower 700$.This hence creates a surplus (Isaac, 2014).
The latter is done mostly with an aim of increasing equality. a price ceiling can be initiated given that the policymakers sense that the equilibrium price is not fair to the consumers while a price floor is put in place if the policymakers realize that the equilibrium price is not fair to the sellers(Isaac, 2014).
For us to understand the reason as to why the standard total cost curve is U-shaped there is need for looking at its key components.
Total cost= all fixed cost + the total cost which is variable.
TC= TVC+TFC
The variable cost is a term used to refer to the cost that increases in any given product. For instance, the materials used to make the product, the labor (in any given case whereby one wants to generate additional units, then he or she requires additional raw materials and labor. The fixed cost is a term that is used to the kind of costs that do not get altered with the change in the products. A good example is the rent of a company in that if a producer makes a decision of either increasing or reducing the products, the rent is bound to remain the same (Isaac, 2014).
This therefore means:
Totality cost/generation=total variable cost/ generation + total fixed cost/generation.
Therefore we get:
Let’s consider a graph so that we get a clear picture of an explanation.
X-axis: Output
Y-axis: cost
The output increases with the increase in the total variable cost and hence the AVC changes in the same manner. However, the total fixed cost does not change and hence the average fixed cost (AFC) is noted to be falling. Due to the fact that the ATC= AFC+AVC and one item is coming down while the other is rising, the side to which the average total cost moves will depend on which element is dominating(Isaac, 2014).
The portion of the U-shaped curve which is downward sloping comes to a correspondence with the portion whereby the average fixed cost (AFC) is dominant and hence ATC is falling but at long run AVC becomes the dominating item and the average total cost (ATC) begins to rise(Isaac, 2014).
References
Isaac, R. M., & Plott, C. R. (2014). Price controls and the behavior of Dutch auction markets: An experimental assessment. The American Economic Assessment, 62(5), 267-421.
Steven, M., Rese, M., Soth, T., Strotmann, W. C., & Karger, M. (2013, April). Profitability of Industrial Product Service Systems (IPS²)–Estimating price floor and price ceiling of innovative challenge solutions. In Proceedings of the 19th CIRP Design Conference– Competitive Design. Cranfield University Press.
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