Which of the following would cause the price of a good to increase above the equilibrium price and stay there permanently? (A) Consumers’ incomes decreased (B) An effective price ceiling (C) Taxes for producers increased (D) The price of a substitute product decreased (E) An effective price floor
The Correct Answer and Explanation is :
The correct answer is (E) An effective price floor.
Explanation:
A price floor is a government-imposed minimum price that is set above the equilibrium price. This is typically implemented to ensure that producers receive a minimum income for their products, especially in markets for essential goods like agricultural products, where price fluctuations could affect the livelihoods of farmers.
When a price floor is set, if it is above the equilibrium price, it leads to an increase in the price of the good. The equilibrium price is the price where the quantity demanded by consumers equals the quantity supplied by producers. However, if the price is forced above this level (through a price floor), it will result in the following:
- Increased Price: Consumers now face a price that is higher than they would naturally pay in an unregulated market, meaning they might purchase less of the good, while producers are willing to supply more at this higher price.
- Surplus: Since the higher price reduces consumer demand but increases producer supply, there is a surplus of goods in the market. In a typical market, this surplus would drive prices down toward equilibrium, but the price floor prevents this adjustment because the price cannot fall below the floor.
- Permanent Effect: As long as the price floor is in place, the price will remain above the equilibrium price, leading to a persistent surplus. This means that producers will continue to supply the good at the higher price, but the market will not clear (i.e., not all the goods will be sold to consumers).
Other options:
- (A) Consumers’ incomes decreased: This would likely decrease demand, leading to a potential decrease in the price of the good, not an increase.
- (B) An effective price ceiling: A price ceiling is a maximum allowable price, set below the equilibrium price, which would lead to a shortage, not a permanent increase in price.
- (C) Taxes for producers increased: This would likely raise the cost of production, which might shift the supply curve leftward, but it does not guarantee that the price will increase permanently above the equilibrium.
- (D) The price of a substitute product decreased: This would likely decrease demand for the good in question, potentially lowering its price.
Thus, a price floor is the only option that ensures a permanent increase in price above equilibrium.