Page 1 of 4                              PARALLEL CLASSES 
                    MICROECONOMICS (CLASS 11 &12) 
                              CHAPTER- 12 
         SIMPLE APPLICATIONS OF TOOLS OF DEMAND AND SUPPLY 
                                CURVES 
       Words that matter 
       1.  Price ceiling: When the government imposed upper limit on the price (maximum price) of a 
       good or service which is lower than equilibrium price is called price ceiling. 
       2.  Price floor: When the government imposed lower limit on the price (minimum price) that may 
       be charged for a good or service which is higher than equilibrium price is called price floor. 
       3.  Rationing: Under rationing system, a certain part of demand of the consumers is met at a price 
       lower than the equilibrium price. Under this system, consumers are given ration coupons/ Cards 
       to buy an essential commodities at a price lower than the equilibrium price from Fair price/Ration 
       Shop. 
       3.  Black market: It is a market under which the commodity is bought and sold at a price higher 
       than the maximum price fixed by the government. 
        
       Price Ceiling (Maximum Price Ceiling) 
       1. When the government imposes upper limit on the price (maximum price) of a good or service 
       which  is  lower  than  equilibrium  price  is 
       called price ceiling. 
       2.  Price  ceiling  is  generally  imposed  on 
       necessary  items  like  wheat,  rice,  kerosene 
       etc. 
       3. It can be explained with the help of given 
       diagram:- 
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      (a) In the given diagram, DD is the market demand curve and SS is the market supply curve of 
      Wheat. 
      (b) Suppose, equilibrium price OP is very high for many individuals and they are unable to afford 
      at this price. 
      (c) As wheat is necessary product, government has to intervene and impose price ceiling of OP1, 
      which is below the equilibrium level. 
      (d) When the government fixes the price of a commodity at a level lower than the equilibrium 
      price (say it fixes the price at OP1, there would be a shortage of the commodity in the market. 
      Because  at  this  price  demand  exceeds  supply.  Quantity  demanded  is  P1M1,  while  quantity 
      supplied is only P1M. There is, thus, a shortage of MM1 quantity at this price (i.e., OP1). In free 
      market, this excess demand of MM1 would have raised the price to the equilibrium level of OP. 
      But, under government price-control consumers’ demand would remain unsatisfied. 
      (e) Though the intension of the government was to help the consumers, it would end up creating 
      shortage of wheat. 
      (f) To meet this excess demand, government may use Rationing system. 
      (g) Under rationing system, a certain part of demand of the consumers is met at a price lower than 
      the equilibrium price. Under this system, consumers are given ration coupons/ Cards to buy an 
      essential commodities at a price lower than the equilibrium price from Fair price/Ration Shop. 
      (h) Rationing system can create the problems:- 
      i. Inferior quality goods-  
      i. Difficulty in purchasing the goods from ration shops-  
      i. Black marketing- 
      Rent Control 
      Rent control is another example of price ceiling. Here government fixes the maximum rental 
      price of housing units below the market equilibrium. The maximum rent fixes by the government 
      helps to prevent the exploitation of lower and middle- income groups by the rich landlords. The 
      equilibrium rent determine by the market happens to be high because demand for rental housing 
      tends to be relatively greater than supply of it. 
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      Price Floor (Minimum Price Ceiling) 
      1. When the government imposes lower limit on the price (minimum price) that may be charged 
      for a good or service which is higher than equilibrium price is called price floor. 
      2. Price Floor is generally imposed on agricultural price support programmes and the Minimum 
      wage legislation. 
      (a) Agricultural price support programmes: Through an agricultural price support programme, the 
      government imposes a lower limit on the purchase price for some of the agricultural goods and 
      the floor is normally set at a level higher than the market—determined price for these good. 
      (b) Minimum wage legislation: Through the minimum wage legislation, the government ensures 
      that  the  wage  rate  of  the  labourers  does  not  fall  below  a  particular  level  and  here  again  the 
      minimum wage rate is set above the equilibrium wage rate. 
      3. It can be explained with the help of given diagram:- 
      (a) In the given diagram, DD is the market demand curve and SS is the market supply curve of 
      Wheat. 
      (b) Suppose, equilibrium price OP is not so profitable 
      for farmers, who have suppose just faced Drought. 
      (c)  To  help  farmers  government  must  intervene  and 
      impose  price  floor  of  P1;  which  is  above  than 
      equilibrium price. 
      (d) Since, the price P1 is above the equilibrium price P, 
      the quantity supplied P1M2 exceeds the quantity demanded and demanded P1M. There is excess 
      supply. Supplied of Wheat 
      (e) In case of excess supply, farmers of these commodities need not sell at prices lower than the 
      minimum price fixed by the government. 
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      (f) The surplus quantity will be purchased by the government. If the government does not procure 
      the  excess  supply,  competition  among  its  sellers  would  bring  down  the  price  to  the  level  of 
      equilibrium price. 
      Consequences of price support (or price floor) policy 
      Some of the consequences are as follows:- 
     1.  When the minimum support price of the agricultural product is fixed at a higher level than the 
       equilibrium price, the open market price for the consumer increases. 
     2.  The fixation of price floor creates the situation of surplus in the market. 
     3.  Tax payer have to pay more tax to finance the government’s foodgrain purchase as well as 
       storage costs. 
     4.  Income of the farmers increase as a result of minimum support price. 
      Effects of Indirect taxes 
      A significant application of demand and supply analysis is that it explains the incident of indirect 
      taxes such as sales tax and excise duty on commodities. For example, if the sales tax (or excise 
      duty) is imposed on a commodity the question is whether the producer will bear the burden or the 
      consumer who buy the commodity or the burden of the tax would be distributed between the 
      producer and the consumer. 
      Important areas of application of tools of Demand and Supply curves 
       1.  To present data regarding demand and supply. 
       2.  To show the process of equilibrium between different economic activities. 
       3.  To show diagrammatically the various degree of elasticity of demand and supply. 
       4.  To explain the fixation of maximum price and minimum price by the government in the 
         situations of excess demand and excess supply. 
       5.  Determination of equilibrium exchange rate. 
       6.  Determination of economic rent. 
       7.  To explain consumer’s surplus. Etc.