Which of the following best describes the effect of binding price ceilings and binding price floors in a competitive market?

• A. Binding price ceilings create shortages, while binding price floors create surpluses.
• B. Both binding price ceilings and price floors lead to market equilibrium.
• C. Binding price ceilings create surpluses, while binding price floors create shortages.
• D. Binding price ceilings and price floors have no effect on market outcomes.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the definitions of price ceilings and price floors. A price ceiling is a legal maximum price set below the market equilibrium price, while a price floor is a legal minimum price set above the market equilibrium price.
2. Step 2: Analyze the effect of a binding price ceiling. Since it is set below the equilibrium price, it lowers the price that sellers can charge, increasing quantity demanded but decreasing quantity supplied, which leads to a shortage (excess demand).
3. Step 3: Analyze the effect of a binding price floor. Since it is set above the equilibrium price, it raises the price that buyers must pay, decreasing quantity demanded but increasing quantity supplied, which leads to a surplus (excess supply).
4. Step 4: Contrast these effects with the non-binding cases, where price ceilings set above equilibrium or price floors set below equilibrium have no effect because the market price naturally settles within the allowed range.
5. Step 5: Conclude that binding price ceilings cause shortages and binding price floors cause surpluses, which is why the correct description is that binding price ceilings create shortages, while binding price floors create surpluses.