Question 1
This assignment provides an overview on the principles of economics. The study focuses on the concepts of price ceiling, price flooring and cost curve. The reason behind the policymakers choosing to impose price ceiling or price flooring is elucidated in this assignment. The second section of the study highlights on the reasons behind the average total cost curve (ATC) being U- shaped. The study also discusses about the implications of this theory using any practical reasons relating to a business.
a) Price ceiling and price flooring are price controls imposed by the government in free market, which changes the market equilibrium. The government imposes price controls owing to certain reasons but there are huge loss of efficiency with both of them (Frank & Cartwright, 2013).
Price Ceilings are maximum price that the government imposes for specific products as well as services, which is sold at high price and hence customers require help in buying them. The government utilizes price ceilings in order to protect customers from the conditions, which could make products prohibitively expensive. Several problems might occur if the government imposes impractical price ceilings, thereby causing economic crisis and business failure.
When price ceiling is set above equilibrium price, then there will be no direct impact. Price ceiling can become an issue when the price is set below market price. If the government set price ceiling below market price, then shortage or excess demand will be created. The producers would not produce at lower price while the customers will demand more as the products are cheaper. As demand outstrips supply, several consumers will want to purchase products at lower price but could not. This shortage of goods might lead to customers queuing up in the line to obtain the products. However, those consumers who waits in the queue actually gets the product. The effect that might occur is that sellers would lower the product quality in order to gain higher profit. Moreover, this might also lead to development of black market and government rationing.
In this case, price ceiling set at $300 would cause shortage of near about 4000 ten- speed bicycles. This is because at this price the quantity demanded for ten- speed bicycles will exceed the quantity supplied. However, the consumers willing to purchase this product might not be able to buy it due to excess demand in the market. Price ceiling is considered to be binding if the government sets it at any price below the market price. In this condition, as the equilibrium price in the bicycle market is $500, this will be binding price ceiling.
a) Price Ceiling
b) Price floors are the government imposed price limit on particular products, which they believe are sold with low price in the unfair market and hence their manufacturers deserve support. Price floors becomes an issue when it is imposed above the equilibrium price but have no impact if it is imposed below the market price. When the government sets price floor above the equilibrium price, excess supply occurs in the market. The consumers will avoid to purchase products at higher price and thus products might go unsold. However, if the suppliers observe that there is not sufficient demand in the market, they might reduce the production of good (Rios, McConnell & Brue, 2013).
In this case, price floor set at $700 would cause surplus or excess supply of near about 4000 ten- speed bicycles. This is because at this price the quantity supplied will exceed the quantity demanded for bicycles (Taussig, 2013). However, as the consumers will avoid to purchase this product at higher price, the suppliers might tend to reduce the quantity in future. Price floors is considered to be binding if the government sets the price above the equilibrium price. In this situation, as the market price of bicycles is $500, this would be considered as binding price floor.
c) Price controls are the restrictions on prices that is imposed by the government that is charged for products as well as services. The main reason behind the policymakers implementing such price control is the desire in maintaining affordability of products during shortages and in slowing inflation level. Alternatively, the government imposes price control in order to assure minimum income for the providers of particular products or minimum wage. The intent of the government behind imposing price ceiling is to protect the consumers from certain situations that might make goods expensive. On the other hand, the government imposes price floor in order to restrict prices of the products from being very low. However, several reasons might exist for the policymakers to set price floor and price ceiling in the market. This is oftenly imposed by the government in an effort to enhance equality. Price ceiling can be set if the policymakers perceive that market price is unfair to the buyers (Rader, 2014). On the other hand, price flooring might be imposed if the policymakers perceive that the market price is unfair to the sellers. Overall, the government imposes such price control in order to make both the consumers and producers maximize profit on the products and service being sold to the market.
b) Price Floor
Average total cost (ATC) is defined as total cost per unit of the output that is attained when the entity involves in the short- run production. It is also defined as summation of average variable cost and average fixed cost. Generally, the ATC declines with the extra production at moderately less quantities of total output and then eventually rises with total output (Varian, 2014). This design is mainly described by U- shaped ATC curve. One of the vital characteristics of ATC curve is that it is U- shaped. This means that it has negative slope mainly for less output, then reaches minimum value and then has positive slope for huge quantities of output. However, the U-shape of ATC curve is indirectly attributable to law of diminishing marginal returns. Moreover, the law of diminishing marginal returns is mainly responsible for positive- sloped portion of ATC curve while the negative sloped portion is mainly attributable to rising marginal returns (Hall & Lieberman, 2012).
The ATC curve is U- shaped as increase in total output increases returns as well as reduces total cost. When the curve slopes downward, it moves into a stage of constant returns in which output as well as returns are at optimum level (Sloman, Norris & Garrett, 2013). After this phase, continuous rise in total output stops providing any increments in returns and thus total cost starts to increase, thereby forces this curve to slope upwards. ATC is mainly influenced by the variable cost as fixed cost remains unchanged. The fixed average cost curve (AFC) slope downwards as total output increases while average variable cost (AVC) forms U curve because of variable proportions principle. Thus, ATC curve is U- shaped (Goodwin et al., 2015).
This can be explained with the help of practical example. Suppose in a bakery business, a bakery cannot be formed without having proper equipment such as ovens and building. While producing baked products, average cost is high as few products are made and fixed cost of oven is high. As the business owner makes more baked products, average cost declines since more product units are made in same ovens. After reaching a certain point, law of diminishing marginal returns arises and variable cost increases.
Conclusion
From the above discussion, it can be concluded that the government imposes price control in order to maintain equality in price in the market. Owing to this, it might impact both the consumers and producers in the market. In addition to this, it is seen from this study that ATC curve is U- shaped because of two reasons- one is fixed cost and the other is law of diminishing marginal returns.
References
Frank, R., & Cartwright, E. (2013). Microeconomics and behaviour. McGraw Hill.
Goodwin, N., Harris, J. M., Nelson, J. A., Roach, B., & Torras, M. (2015). Principles of economics in context. Routledge.
Hall, R. E., & Lieberman, M. (2012). Microeconomics: Principles and applications. Cengage Learning.
Rader, T. (2014). Theory of microeconomics. Academic Press.
Reisman, D. (2013). The Economics of Alfred Marshall (Routledge Revivals). Routledge.
Rios, M. C., McConnell, C. R., & Brue, S. L. (2013). Economics: Principles, problems, and policies. McGraw-Hill.
Sloman, J., Norris, K., & Garrett, D. (2013). Principles of economics. Pearson Higher Education AU.
Taussig, F. W. (2013). Principles of economics (Vol. 2). Cosimo, Inc..
Varian, H. R. (2014). Intermediate Microeconomics: A Modern Approach: Ninth International Student Edition. WW Norton & Company.
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