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Difficulty: MediumPrice Controls: Ceilings and Floors

The domestic market demand and supply equations for premium motor spirit (PMS) in a region are given by Qd=600−PQ_d = 600 - P and Qs=150+0.5PQ_s = 150 + 0.5P, where PP is the price per litre in Naira (₦) and QQ is the quantity in millions of litres. If the government enforces a maximum price ceiling of ₦200 per litre, which of the following best describes the resulting market outcome?

  1. A market shortage of 150 million litresAnswer
  2. B
    A market surplus of 150 million litres
  3. C
    An outward shift of the demand curve by 150 million litres
  4. D
    A market surplus of 400 million litres

Answer

The maximum price ceiling of ₦200 per litre creates a market shortage of 150 million litres.
Substituting the price ceiling of ₦200 into the market equations yields a quantity demanded of 400 million litres and a quantity supplied of 250 million litres. Because quantity demanded exceeds quantity supplied by 150 million litres, the legal maximum price ceiling results in an excess demand (shortage) of 150 million litres.

Step-by-Step Solution

1
Calculate quantity demanded (QdQ_d) at the price ceiling of P=200P = 200
Qd=600−200=400Q_d = 600 - 200 = 400 million litres
Substitute the price ceiling value into the demand function.
2
Calculate quantity supplied (QsQ_s) at the price ceiling of P=200P = 200
Qs=150+0.5(200)=150+100=250Q_s = 150 + 0.5(200) = 150 + 100 = 250 million litres
Substitute the price ceiling value into the supply function.
3
Determine the market balance by evaluating Qd−QsQ_d - Q_s
400−250=150400 - 250 = 150 million litres excess demand
Because Qd>QsQ_d > Q_s at a price below equilibrium (Pe=300P_e = 300), a binding price ceiling creates an economic shortage.

Key Concept

Price Ceiling and Market Shortage Calculation
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Topics

Price Controls: Ceilings and Floors

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