Question 1 Explain, with the aid of a diagram, what happens in the market for (say) electricity if the government fixes a maximum price below the equilibrium price?

When the government fixes a maximum price below the equilibrium price in the market for electricity, it creates a situation known as a price ceiling. This means that the price of electricity cannot go above a certain level set by the government.

In the diagram below, the original equilibrium price is P1 and the original equilibrium quantity is Q1. When the government sets a maximum price below the equilibrium price, it creates a shortage of electricity at the new price level (P2). At the maximum price, consumers are willing to buy more electricity (Q2) than producers are willing to supply (Q3), leading to a shortage of electricity in the market.

This shortage can lead to various consequences such as blackouts, long waiting times, or the creation of a black market where electricity is sold at a higher price. Overall, fixing a maximum price below the equilibrium price in the market for electricity can distort the market and lead to inefficiencies.

[Diagram]
[Original equilibrium price (P1) and quantity (Q1) marked on the graph]
[Maximum price set by the government (P2) below the equilibrium price]
[Shortage of electricity between Q2 and Q3]

When the government fixes a maximum price below the equilibrium price, a surplus is created. This is because the quantity supplied is greater than the quantity demanded at the maximum price. The diagram below illustrates this:

[Image of a supply and demand curve with a maximum price below the equilibrium price]

At the maximum price, Pmax, the quantity supplied is Qs and the quantity demanded is Qd. The surplus is Qs - Qd.

The surplus can lead to a number of problems, including:

- Reduced production: Producers may be unwilling to produce as much electricity at the maximum price, as they will not be able to make a profit. This can lead to shortages of electricity.
- Black markets: The surplus may create a black market for electricity, where it is sold at a higher price than the maximum price. This can lead to corruption and other illegal activities.
- Government intervention: The government may need to intervene in the market to prevent the surplus from causing problems. This could involve buying the surplus electricity or subsidizing producers.

In general, it is not advisable to fix a maximum price below the equilibrium price. This can lead to a number of problems, including shortages, black markets, and government intervention.