Price Controls
Price control or regulations refers to the setting of an upper or lower limit on the price at
which a particular product can be bought or sold.
An upper limit is a price ceiling and a lower limit is referred to as a price floor.
The objectives of price controls
To keep the prices of products at levels which can be afforded by most people especially
prices of basic goods such as cooking oil.
To stabilises prices, that is, to control the persistent increase in the general level of prices.
The maintenance of incomes of producers at higher levels than that which would be produced
by market forces, e.g. incomes of farmers
PRICE CEILING OR MAXIMUM PRICE
A price ceiling is the maximum price a seller is allowed to charge for a product or service.
Price ceilings are usually set by law and limit the seller pricing system to ensure fair and
reasonable business practices.
Price ceilings are often set for essential expenses; for example, some areas have rent ceilings
to protect renters from climbing rent prices.
A price ceiling occurs when the government puts a legal limit on how high the price of a
product can be.
In order for a price ceiling to be effective, it must be set below the natural market equilibrium.
When a price ceiling is set, a shortage occurs.
For the price that the ceiling is set at, there is more demand than there is at the equilibrium
price.
There is also less supply than there is at the equilibrium price, thus there is more quantity
demanded than quantity supplied.
The max price $10 the consumers will demand 13 quanties while producers will suppy 5
quantities.
Quantity supplied will be in short supply they will be excess demand on the market which is
equal to 13-5 = 8
Effects of price ceiling or max prices
Black Market / parallel markets will emerge, since people will buy at low prices and later on
sell their products at high prices.
Queue/first come first serve. This will result in consumer to spend more time in queues
waiting for goods to be sold to them.
It promotes hording of goods and sell them to informal markets where prices are high because
they are no price controls.
It results in inflation.
The shortages will result in sellers only to sell goods to their friends and relatives.
Consumption by the poor will decrease and this results in poor standards of living.
Producers will produce less output fearing losses.
Consumer surplus and producer surplus will be affected as a result controls.
Price Floors
A price floor is the lowest legal price a commodity can be sold at.
This is when the government price above the equilibrium.
Price floors are used by the government to prevent prices from being too low.
The government sometimes set minimum price of the commodity to protect producers.
The most common price floor is the minimum wage, the minimum price that can be paid for
labour.
In the labour market, the government set a low minimum wages to protect the employees
from poor or low wages
Price floors are also used often in agriculture to try to protect farmers.
For a price floor to be effective, it must be set above the equilibrium price.
If it's not above equilibrium, then the market won't sell below equilibrium and the price floor
will be irrelevant.
This graph shows a price floor.
The price floor is above the equilibrium price.
In the market quantity supplied is greater than quantity demanded (QS>QD)
There is less quantity demanded (consumed) than quantity supplied (produced). This is called
a surplus.
If the surplus is allowed to be in the market then the price would actually drop below the
equilibrium.
In order to prevent this, the government must step in. The government has a few options:-
1. They can buy up all surplus.
2. They can strictly enforce the price floor and let the surplus go to waste. This means that
the suppliers that are able to sell their goods are better off while those who can't sell theirs
(because of lack of demand) will be worse off. Minimum wage laws, for example, mean
that some workers who are willing to work at a lower wage don't get to work at all. Such
workers make up a portion of the unemployed (this is called "structural unemployment").
3. The government can control how much is produced. To prevent too many suppliers from
producing, the government can give out production rights or pay people not to produce.
Giving out production rights will lead to lobbying for the lucrative rights or even bribery.
If the government pays people not to produce, then suddenly more producers will show
up and ask to be paid.
4. They can also subsidize consumption. To get demanders to purchase more of the surplus,
the government can pay part of the costs. This would obviously get expensive really fast.
NOTE : In the end, a price floor hurts society more than it helps. It may help farmers or the few
workers that get to work for minimum wage, but it only helps those people by hurting everyone else.
Price floors cause a deadweight welfare loss.
The excess amount, that, a consumer will be left with after paying for a product.
It is called consumer surplus or buyer surplus in the sense that some consumers will be
willing to pay higher price than the equilibrium price.
The consumer surplus is the area below the demand curve but above the equilibrium or
market price as shown above in (a).
A deadweight welfare loss occurs whenever there is a difference between the price the
marginal demander is willing to pay and the equilibrium price as shown above in graph (b).
The deadweight welfare loss is the loss of consumer and producer surplus. In other words,
any time a regulation is put into place that moves the market away from equilibrium,
beneficial transactions that would have occured can no longer take place.
In the case of a price floor, the deadweight welfare loss is shown by a triangle on the left side
of the equilibrium point, like in the graph below.
The area of the triangle is the amount of money that society loses.
Inefficiency occurs since at the price ceiling quantity supplied the marginal benefit exceeds
the marginal cost.
This inefficiency is equal to the deadweight welfare loss.