What is the consequence if the government sets a price ceiling on petrol at Rs150 per litre while the market equilibrium price is Rs100 per litre ?
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Answer: A. A significant increase in the demand for petrol could cause the price ceiling to become a binding constraint.
Explanation
A price ceiling set above the equilibrium price is initially non-binding. An increase in demand raises the equilibrium price until it reaches the ceiling. At that point, the ceiling becomes a binding constraint causing severe market shortages. Price ceilings establish legal maximum prices that sellers may charge for goods. Ceilings set below equilibrium create immediate shortages by restricting market clearing. Shifts in supply or demand can transform non-binding price controls into binding constraints.
Rent control laws often begin as non-binding ceilings before inflation makes them binding. Binding price ceilings frequently lead to black markets and reduced product quality. Governments analyze equilibrium dynamics to anticipate the consequences of price interventions. An increase in supply would lower equilibrium prices further below the ceiling. Surpluses occur when price floors are set above market equilibrium prices. Price ceilings create shortages rather than surpluses when they constrain market prices.
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