Price controls

• What are price controls?

  • Price controls are a type of government intervention in markets to change the existing market price
  • To correct market failure, price controls are used to influence the levels of production or consumption in markets that are failing to allocate resources efficiently
• What are the 2 types of price control?

  • Two types of control are commonly used: maximum price (price ceiling) and minimum price (price floor)
• Example of a maximum price control?

  UK set energy price cap in Apr-Jun 2024
• Example of a minimum price control?

  Scotland have a minimum price per unit of alcohol
• What is a price ceiling?

  • A price ceiling is a maximum price set by the government. Sellers cannot legally sell the good or service at a higher price
  • The price ceiling is set below the existing equilibrium market price  
  • Governments will often use price ceilings in order to help consumers if the market price is too high, especially for essential goods and services
  • Sometimes they are used for long periods of time e.g. rent controls to keep rents lower in housing rental markets
  • Other times, they are short-term solutions aimed at limiting unusual price increases e.g. petrol
• What does this diagram show about the impact of a price ceiling?

  • initial market equilibrium -PeQe
  • price ceiling imposed at Pmax below equilibrium level
  • lower price reduces incentive to supply. There's a contraction in QS from Qe → Qs
  • lower price increases incentive to consume and there is an extension in QD from Qe → Qd
  • This creates a condition of excess demand (shortage) equal to QsQd
  • The aim of this policy is to promote equity in the market for essential goods and services and it attempts to solve market failure caused by income inequality

  
• What are advantages of price ceilings?

  • Some consumers benefit as they purchase at lower prices. For these consumers, their consumer surplus increases
  • Price ceilings can stabilise markets in the short-term during periods of intense disruption, e.g. Covid supplies at the start of the pandemic
• What are disadvantages of price celings?

  • Some consumers are unable to purchase due to shortage
  • Producers lose out as price is below what they usually receive: producer surplus falls
  • unmet demand can encourage creation of illegal markets and exploitation of consumers
  • Maximum prices distort market forces and can result in inefficient allocation of scarce resources (housing shortages)
  • When used in necessity markets, Governments may be forced to intervene further by supplying the good/service themselves in order to meet the excess demand
• What are price floors?

  • A price floor (minimum price) is set by the government above the existing free market equilibrium price and sellers cannot legally sell the good/service at a lower price
  • Governments will often use price floors to help producers or to decrease consumption of a demerit good
  • In Wales and Scotland, governments have introduced a minimum price of alcohol at 50 pence per unit
  • Minimum prices are also used in the labour market to protect workers from wage exploitation. These are called minimum wages
• What does this diagram show about the impact of price floors?

  • The initial market equilibrium is at PeQe
  • A price floor is imposed at Pmin above the equilibrium level
  • The higher price increases the incentive to supply and there is an extension in supply from Qe → Qs
  • The higher price decreases the incentive to consume and there is a contraction in demand from Qe → Qd
  • This creates an excess supply equal to QdQs 
  • In the case of demerit goods, this discourages consumption, reducing output to a level closer to the socially optimal level of output

  
• What are some advantages of price floors?

  • In agricultural markets, producers benefit as they receive a higher price (Governments will often purchase the excess supply and store it or export it)
  • Producers are protected from price volatility
  • When used in demerit markets, output falls (Governments will not purchase the excess supply of a demerit good)
  • Producers usually lower their output in the market to match the QD at the minimum price and this helps to reduce the external costs
• What are some disadvantages of price floors?

  • It costs the government to purchase the excess supply and an opportunity cost is involved
  • Some producers such as farmers may become over-dependent on the Government's help
  • Producers lower output which may result in an increase in unemployment in the industry
  • If demand is price inelastic, the increase in price does not impact QD or solve the market failure