Theory question 110
Price Determination(a) With the aid of a diagram, explain the effects of fixing a price (i) above the equilibrium price; (ii) below the equilibrium price
(b) (i) What is an abnormal demand? (ii) Give two reasons for its occurrence
Show the model answer
(a)(i) Minimum price above equilibrium: quantity supplied exceeds quantity demanded, giving a surplus (glut); government may buy up the surplus; diagram shows the price line above Pe with Qd < Qs.
(ii) Maximum price below equilibrium: quantity demanded exceeds quantity supplied, giving a shortage; leads to queues, rationing, hoarding and black markets; diagram shows the price line below Pe with Qd > Qs.
(b)(i) Abnormal demand is when more of a commodity is bought as its price rises (or less as it falls), contrary to the law of demand; the demand curve slopes upward.
(ii) Any two: Giffen goods; goods of ostentation/prestige (Veblen goods); expectation of further price rise; ignorance (price taken as a sign of quality); emergencies/scarcity; habit-forming goods.
Diagrams must show demand, supply, equilibrium and the fixed price with the gap labelled.