Excess supply / demand & price floor / ceiling?
Would this result in excess supply or excess demand? is this a price floor or price ceiling?
How do i differentiate all these?
Answer:
If the market equilibrium price is 6, and equilibrium quantity is 400, that point is where the supply and demand curves intersect for the dollar in China.
If the government fixes the price at 8, in this case, it is actually imposing a price floor. The market wants the price of the dollar to be lower (at 6) but the government requires it to be higher (8), i.e. the minimum price is 8. A price ceiling would be a situation where the market wants the price to be higher (as in the S & D intersection/equilibrium occurs at a higher price) but the government's restriction forces the price to be lower.
With the price at 8, there will now be an excess supply, as the quantity demanded at 8 on the demand curve (which will be less than 400) is smaller than the quantity supplied at 8 on the supply curve (which will be more than 400).
The dead weight loss... this will be tricky to describe without a graph but I'll give it a shot:
The DWL will be calculated as 0.5(400 - qty demanded at price 8.0) * (8.0 - price of qty supplied at qty demanded)
This will visually look like the area in between the two curves to the left of the equilibrium extending up until the new quantity demanded at price 8.0.
Hope that helps.
When Chinese Govt. fix the exchange rate of 1$=8 RMB, it is both a floor price or a celing price. IT is fixed official price. However, the money changers could add a small fee for effecting transaction of money change.But this can be ignored.
So the official market exchange rate is fixed (both ceiling and floor).
But this official price according to you does not reflect the equilibrium exchange rate which is $1= 6RMB. Thus the RMB is officially undervalued. This means at the official exchange rate it is costlier for the local Chinese to import US goods than it would have been under equilibrium. It also means that the US finds it cheaper to import Chinese goods as compared to the equilibrium situation. Under such circumstances the US will tend to buy more from China and the Chinese will buy less from the US. Thus compared with the equilibrium situation the supply of dollars to fund purchase of Chinese goods will be higher, whereas the demand for dollars by chinese to purchase US goods will be lower. Thus, there will be continuous excess supply of dollars against the RMB unless the excess dollars are used by the Chinese Govt. to invest in financial assets/ treasury bills in the US. In the absence of such correction and even with that, the unofficial / black market will always expect the value of dollar in terms RMB to fall. But this will not lead to change in the official exchange rate fixed by the Chinese govt. Thus, there being no free market for foreign exchange in Cjina, the deviation from market equilibrium will not result in the operation of dynamic market forces to let the exchange rate move back to an equilibrium.
The problem in understanding that you face is because you have not seen markets where the Govt, fixes the price operating. It is a rationing syste,. But all rationing system results in black market operations. This must be happening in China also: dollars being sold and bought illegally. But the Chinese Govt. dictates everything in that country and controls everything. So the black market is sought to be controlled. But by keeping the RMB undervalued, the Chinese are forced to sell ghinese goods at a cheaper price. That is a loss to Chinese economy.
I'm applying what I learnt last night from my International Monetary Economics Topic 1 here:
There would be neither excess demand nor supply.
A little tricky because the "price" depends on which ratio you adopt. The natural one is RMB/$, which is how the problem is stated. But flip it to $/RMB and you get equally valid (but opposite) answers.
It's a price floor for the $ in terms of RMB. It's a price ceiling for RMB in terms of $.
There is an excess demand for RMB to exchanged into $. There is an excess supply of $ to be exchanged into RMB.
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