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Maximum and Minimum
Prices
DP Economics
Maximum Prices
• Governments can legally set a maximum price in
a market that suppliers cannot go above.*
• To be effective a maximum price has to be set
below the free market price.
• The price for wheat is a good example of
maximum price setting when a shortage of
wheat threatens a very large rise in the free
market price
• Other examples include rent controls on
properties – for example the complex system of
rent controls still in place in Manhattan.
Illustrating the effects of a maximum price
Rent
£s
Free Market
Equilibrium
Supply
Pe
Demand
Quantity of Rented
Property
Illustrating the effects of a maximum price
Supply
Rent
£s
Free Market
Equilibrium
Pe
P max
Price (Rent) Ceiling
Excess
Demand
Demand
Q2
Q1
Quantity of Rented
Property
Black markets
• A parallel market can occur when the normal market
price is higher than a legally imposed price ceiling
(or maximum price).
• Black markets develop where there is excess
demand (or a shortage) for a good/ service.
• Some consumers are prepared to pay higher prices
in black markets in order to get the goods or
services they want.
• When there is a shortage, higher prices act as a
rationing device in the free market.
Potential black market for a good/ service
Price
£s
Supply
Free Market
Equilibrium
P1
Red area is a
potential black
market*
Pe
P max
Price Ceiling
Excess
Demand
Demand
Q3
Q2
Q1
Quantity
Examples of black markets*
• Tickets for major sporting events, rock concerts
• Black markets for children’s toys and designer
products that are in scarce supply
• Black market for the anti-impotence drug Viagra
and its new rival products now coming onto the
market
• Black markets in the illegal distribution and sale
of computer software products and pirated DVDs
and music (the maximum price is zero! Or even
negative if you include fines.)
Minimum prices
• Governments can legally set a minimum price in
a market that suppliers cannot go below.
• To be effective the minimum price has to be set
above the normal equilibrium price
• A good example of this is minimum wage
legislation currently in force in the UK*
• The main adult rate for the minimum wage in the
UK is now £5.05 per hour
Illustrating the effects of a minimum price
Wage
Rate
(W)
Labour
Supply
Excess supply of
labour due to the
minimum wage
Wmin
Minimum Wage (Wage Floor)
We
Excess unemployed
willing to work
Demand
for Labour
E3
Ee
E1
Employment of Labour (E)
Main justifications for the minimum wage*
• The equity justification:
• Fair rate of pay commensurate with the skills and
experience of an employee
• Labour market incentives:
• The NMW is designed to improve the incentives for
people to start looking for work
• Labour market discrimination/ exploitatation
• The NMW is a tool designed to offset some of the
effects of persistent discrimination of many low-paid
female workers and younger employees
Disadvantages of a minimum wage
• Competitiveness and Jobs:
• A minimum wage may cost jobs because a rise in
labour costs makes it more expensive to employ
people.
• Effect on relative poverty:*
– The greatest risk of relative poverty is among the
unemployed, elderly and single parent families where
the parent is not employed. They don’t benefit from
the NMW
• Rising prices due to supply costs increase
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