Answer
A price floor is set above current market equilibrium. At market equilibrium, demand and supply are equal and the market is in harmony. Once a price floor is set, demand and supply are no longer in equilibrium: supply exceeds demand and a surplus is generated. Producers are willing to sell a greater quantity at the new price after the price floor has been imposed but consumers are not willing to buy the same quantity. Resource allocation is thus distorted as the true quantity supplied and demanded differs from what it would be in a free market. Prices are also artificially raised and thus different to what they would be in a free market.
When a price ceiling is imposed, a maximum price is imposed. This is the opposite of a price floor and results in excess demand but too little supply. This causes a shortage of goods and thus distorts the resource allocation and the rationing function of prices.
Work Step by Step
PREVIEW
A price floor is set above current market equilibrium. At market equilibrium, demand and supply are equal and the market is in harmony. Once a price floor is set, demand and supply are no longer in equilibrium: supply exceeds demand and a surplus is generated. Producers are willing to sell a greater quantity at the new price after the price floor has been imposed but consumers are not willing to buy the same quantity. Resource allocation is thus distorted as the true quantity supplied and demanded differs to what it would be in a free market. Prices are also artificially raised and thus different to what they would be in a free market.
When a price ceiling is imposed, a maximum price is imposed. This is the opposite of a price floor and results in excess demand but too little supply. This causes a shortage of goods and thus distorts the resource allocation and the rationing function of prices.
