Price Mechanism Fails Under Government Price Controls

Steps:

• Recall that the price mechanism allocates goods by letting prices rise or fall to balance supply and demand.
• Identify scenarios where prices cannot freely adjust, preventing efficient allocation.
• Evaluate each option: A fixes prices below equilibrium, causing shortages; B limits promotion but allows price signals; C is normal scarcity handled by prices; D distorts competition but prices still signal somewhat.
• Conclude the mechanism fails completely when government enforces a binding price limit.

Why A is correct:

• An effective maximum price (price ceiling) below equilibrium stops prices from rising to ration scarce goods, leading to excess demand and non-price allocation like queues, violating the price mechanism's core function of market-driven distribution.

Why the others are wrong:

• B: Banning advertising reduces demand information but doesn't prevent prices from adjusting supply and demand.
• C: Limited supply triggers the price mechanism to increase prices and allocate efficiently.
• D: A powerful company (monopoly) sets higher prices, but the mechanism still operates through market signals, albeit inefficiently.

Final answer: A