3.9 free markets and price controls

• A free market is where the government does not intervene to control prices. Prices adjust based on supply and demand forces, leading to an equilibrium where the market clears excess demand and supply.
• In a free market, if there is excess demand or supply, the price adjusts quickly, allowing the market to reach a new equilibrium.
• • Price controls are government interventions to set minimum (price floors) or maximum (price ceilings) prices, preventing the natural adjustment of market prices.
• • Price floors: These are the minimum prices set by the government (e.g., minimum wage). If set above the equilibrium price, it can lead to excess supply (surplus) as suppliers produce more, but demand decreases.
• Price ceilings: These are the maximum prices set below the equilibrium price. They are used when prices are too high, usually to protect consumers (e.g., rent control, food price caps).

  • Price ceilings can cause excess demand (shortage), where the quantity demanded exceeds the quantity supplied, as the price is kept artificially low.
• Free Markets: Allow prices to adjust naturally based on supply and demand, leading to equilibrium.
• Price Controls: Interventions like price ceilings and floors distort the natural market mechanism, leading to shortages or surpluses.
• A fixed price / price floor enacted by the government usually set above the equilibrium market price
• purpose of price floors:

  • to protect producers from price volatility
  • solve market failure:
  • discouraging consumption
• in price floors:

  price increases

  quantity demanded decreases

  excess supply is created

  cost of intervention buying (gov buys extra supply) : minimum price x QDQS

  with Intervention buying : producers revenue Pmin x Qs

  no intervention buying: producers revenue Pmin x Qd
• consumers don't benefit from price floors : quantity is lower & choice is lower
• PRODUCERS BENEFIT FROM PRICE FLOORS with intervention buying as revenues can rise
• The governments benefit from price floors to protect producers and keeping producers alive but concern about effect on consumers and any losses as it could lead to dumping which causes global relations issues
• a maximum price / price ceiling: a fixed price enacted by the gov usually set below the equilibrium price
• Price ceilings are used to increase affordability of necessity goods / services
• with price ceilings prices fall from equilibrium
• with price ceilings:

  • consumers are benefitted if they have access to the good but
  • producers don't benefit, they have a contraction in supply, they move to other alternatives to supply
  • the government support consumers but concerned on producers leaving the market & the excess demand