Price Control

• Price controls refer to the setting of minimum or maximum prices by

the government (or private organisations) so that prices are unable to
adjust to their equilibrium level determined by demand and supply.
• Price controls result in market disequilibrium, and therefore in
shortages (excess demand) or surpluses (excess supply).
• Price controls differ because, once they are imposed, they do not
allow a new equilibrium to be established, and instead force a
situation where there is persisting market disequilibrium
Maximum price (Price ceiling)
• Definition: A price set up by the government. these are legislation
which require firms to charge under the certain price.
• For a price ceiling or maximum price, the idea is to protect buyers of a
good from prices deemed “too high” by governments;
• the goal is to make the good more accessible by lower income
consumers
• For merit goods
• By imposing a price that is below the equilibrium price, a price ceiling
results in a lower quantity supplied and sold than at the equilibrium
price
Consequence of Price Ceilling
• 1. Shortage:
• not all interested buyers who are willing and able to buy the good are
able to do so because there is not enough of the good being supplied.
(shortage=Qd-Qs)
• 2. Non-price rationing:
• once a shortage arises due to a price ceiling, the price mechanism is
no longer able to achieve its rationing function.
• the quantity Qs be distributed among all interested buyers by non-
price ration:
• a. Queueing: wait in line
• b. Rationing: a limit on the amount that can be consumed
• c. Lottery: the drawing of tickets to decide who will get the products
• 3. Underground market (black market):
• involve buying/selling transactions that are unrecorded, and are
usually illegal.
• Underground markets can arise when there exist dissatisfied people
who have not succeeded in buying the good because there was not
enough of it, and are willing to pay more than the ceiling price to get
it.
• Underground markets are inequitable, and frustrate the objective
sought by the price ceiling.
• 4. Underallocation of resources to the good and allocative
inefficiency:
• there are too few resources allocated to the production of the good,
resulting in underproduction relative to the social optimum. Society is
worse off due to underallocation of resources and allocative
inefficiency.
• 4. Negative welfare impacts

Before After Change

CS a+b a+c +b-c

PS c+d+e e -c-d

Total surplus a+b+c+d+e a+c+e -b-d(DWL)

example questions
• Which of the following might explain a simultaneous increase in both
price and quantity traded in the market for a normal good?
A the removal of an effective maximum price on the good
B technological progress in the production of the good
C the imposition of a tax on the good
D the granting of a subsidy to producers of the good
• 14. A government fixes a maximum price for a product in order to increase
its consumption. What would be the likely outcome of such a policy? (2013
s11)
A Consumption will fall if the maximum price is above the current
equilibrium price.
B Consumption will rise if the maximum price is below the current
equilibrium price.
C Production will fall if the maximum price is above the current equilibrium
price.
D Production will fall if the maximum price is below the current equilibrium
price.
Minimum price (price floor)
• The price that can be legally charged by sellers of the good must not be
lower than the minimum price.

• Price floors are commonly used for those reasons:

• (a) to provide income support for farmers by offering them prices for
their products that are above market determined prices;
• (b) to protect low-skilled, low wage workers by offering them a wage
(the minimum wage) that is above the level determined in the market.
• (c) demerit goods
to have an effect, the price floor must be above the equilibrium price.
If it were below the equilibrium price, the market would achieve equilibrium and the price floor would have
no effect.
Consequences of price floors
• 1. Surplus
• 2. Overallocation of resources to the production of the good and
allocative inefficiency
• Too many resources are allocated to the production of the good,
resulting in a larger than optimum quantity produced.
(overproduction)
• 3. (for agricultural goods): Government measures to dispose of
surpluses.
• 4. nagative welfare impact
Change in total surplus

Before After Change

CS a+b+c a -b-c
PS d+e b+d +b-e
Total a+b+c+d+e a+b+d -c-e (deadweight
loss)
buffer stock scheme
• A buffer stock schemeis designed to smooth price rises and falls by
buying and selling stocks of products depending on market conditions.
• In general terms,buffer stock schemes combine the principles of
minimum and maximum price controls.
• The scheme can also set a maximum price.The effect willbe to
increase supplies from growers which in time will seea reduction in
the price of the product.
• KEY TERM
• buffer stock scheme:a type of commodity agreementdesigned to limit
price fluctuations.
Agricultural products market (buffer
stock) In an agrecultural products market, the objective of
government is to raise the price above their equilibrium
market price;

such price floors are called price supports/ buffer stock

scheme

A common practice is for the government to buy the excess

supply,By buying up the excess supply, the government is able
to maintain the price floor at Pf.

for example A buffer stock scheme starts by setting a

minimum price for a particular product,say potatoes.If the
market price looks like going below this minimum,the buffer
stock scheme will buy up stocks of potatoes from
growers.These will be stored in warehouses.This action should
raise the price of potatoes since supply in the market has
fallen.
Change in aggricultural goods

h i

Before After Change

CS a+b+c a -b-c
PS d+e b+d+f+c+e +b+f
Government 0 -(c+e+f+g+h+i) -(c+e+f+g+h+i)
revenue
Total surplus a+b+c+d+e a+b+d+f -c-e-g-h-i (DWL)