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Question
If the prevailing market price is above the equilibrium price, explain its chain of effects.
Solution
When the price is above the equilibrium market price of a good (OP), the price ceiling leads to excess of supply. In the diagram, the equilibrium price and quantity are OP and OQ. As the equilibrium price is low for farmers, the government fixes the price floor, i.e. the price level increased from OP to OP1 which leads to a decline in the quantity demand, and therefore, there is excess supply in the market. Here, the competition will increase among the sellers, and hence, the price will come down to the equilibrium point where market demand is equal to market supply.
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