Download GOVERNMENT INTERVENTION

GOVERNMENT
INTERVENTION
PRICE CEILING & PRICE FLOOR
Syllabus Outcomes:
• Explain why governments impose price ceilings/
price floors
• Give examples including food price controls and rent
controls
• Draw diagrams to show price ceilings/ price floors
and analyze its impacts on the market outcomes
• Examine the consequences of the price ceiling /price
floors
PRICE CONTROLS


Refer to setting of minimum or maximum prices
by the government or private organizations so
that prices are unable to adjust back to
equilibrium levels determined by the forces of
D+S
Price controls result in disequilibrium and
therefore in shortages (excess D) or surpluses
(excess S)
WHAT IS A PRICE CEILING?


Also known as maximum price - where the price
charged by sellers cannot be higher than the
legally set price ceiling.
This price is normally set BELOW equilibrium
price and therefore results in disequilibrium
leading to shortages in S or excess D at the lower
prices
OUTCOMES OF PRICE CEILING
IMPACTS OF PRICE CEILINGS ON THE MARKET
Lower P charged for the product
 Shortage of S / excess D
 Increase in Qd at lower prices
 Less Qs supplied due to lower P

CONSEQUENCES OF FOR THE ECONOMY
Supply
shortages
Negative
welfare
impacts
Black
markets
Consequences
of P Ceiling
Non price
Rationing
Allocative
inefficiency
Non –price rationing
Waiting in line - sell
to those who come
first
 Distribution of
coupons – limits
amount of goods that
can be bought at a
time
 Favouritism – sell to
preferred customers

Black markets

Selling in illegal
markets goods at high
prices than those set
in the legal market
Allocative inefficiency

Producing lower
quantities – not
supplying what
society wants
Negative impacts on
social welfare




Social welfare = consumer
and producer surplus
Society is worst off because
consumer surplus and
producer surplus are both
reduced due to P ceiling
leading to dead weigh loss
(welfare loss)
consumers are not getting
enough of the good and
producers are not selling
enough either
Qs < Qd
Before P ceiling
Consumer
Surplus (CS)
after Pc
Producer
Surplus (PS)
after Pc
e
CS = a+ b
PS = c+d+e
Social Surplus = CS + PS
= a+b+c+d+e
REAL LIFE EXAMPLES OF PRICE CONTROL


Price ceilings are commonly used for goods that
are considered to be neccesities to ensure that
they remain affordable for consumers
Examples : Rent and food markets
Student task :
• Draw a diagram of the rental market showing
the imposition of price ceiling
• Identify the likely consequences on the market
CONSEQUENCES OF RENT CONTROLS
Rental houses become affordable /cheaper
 Shortage of housing as the Qd at the lower Pc is
higher than quantity available.
 Long waiting list for interested tenants
 Black market – where people sublet their
apartments to others at higher P than Pc
 Rented apartments become run-down and poorly
maintained as it becomes unprofitable for
landlord to spend on their properties
 Less people will be willing to buy properties and
rent them out due to the low rent return.

WHAT IS A PRICE FLOOR?


Also known as minimum price - where the price
charged by sellers cannot be lower than the
legally set price floor
This price is normally set ABOVE equilibrium
price and therefore results in disequilibrium
leading to shortages in D or excess S at the
higher prices
OUTCOMES OF PRICE FLOORS
IMPACTS OF PRICE FLOOR ON THE MARKET
Higher P charged for the product
 Shortage of D / excess S
 Increase in Qs at higher prices
 Less Qd due to higher P

CONSEQUENCES OF FOR THE ECONOMY
Surplus
Government
measures to
deal with
the surplus
Negative
welfare
impacts
Consequences
of P Floor
Firms
inefficiency
Allocative
inefficiency
GOVERNMENT MEASURES TO DEAL WITH
SURPLUS
Price floor result in surpluses due to higher P
causing a fall in Qd ie Qs>Qd.
 As result government must decide on how to best
deal with the surplus to maintain Pf.
Options include:
1. Buy surplus and store it – problem: storage cost
2. Buy surplus and export it – problem may need
to give subsidy to suppliers if P higher than
overseas – again costly for government
3. Sent surplus as AID to poor countries

FIRMS INEFFICIENCY


Refer to firms that produce at higher P than
market equilibrium P, or produce quantities of
goods that does not reflect what society wants.
This means firms either under produce or
overproduce.
In the case of price floors firms overproduce and
sell at the higher P and have no incentive to cut
costs because they are guaranteed higher Pf .
This leads to inefficiency
ALLOCATIVE INEFFICIENCY

Where too much is allocated by firms to the
production of the good resulting in larger than
optimum (best) quantity being produced.
Quantity produced = Qs
 Optimum quantity = Qe

REAL LIFE EXAMPLES OF PRICE FLOORS
Governments commonly use price floors in 2 markets:
a.
The product market (agricultural)
b.
The resource market (labour/ workers)
WHY??? for 2 reasons:
1.
2.
Support incomes for farmers by offering Pf higher
than Pe to guarantee certain income levels.
Protect low skilled, low wage workers by offering
them minimum wages above market levels to ensure
adequate income levels
PRICE FLOOR IN AGRICULTURAL MARKET
WELFARE IMPACTS OF PRICE FLOOR
Increase in
social surplus
= CS + CP
after Pf
CS after Pf
a
f
PS after Pf
Government
spending on the
extra surplus
= Pf x (Qs – Qd)
Society
loses
because
gov’t uses
taxes to
buy
surplus
instead of
spending
on other
goods like
education
and health
WELFARE IMPACTS OF PRICE FLOORS






CS is reduced to (a) from (a+b+c) because they pay
higher P and buy less Q
PS is increased to (b+c+d+e+f) from (d+e) because
they sell at higher P and make more goods
Social Surplus increases by area (f)
Society welfare loss (deadweight loss)= green
rectangle because government spends taxes on buying
surplus rather than on providing services such as
health and education.
Government spending increases – pressure on the
budget
Misallocation of resources because producers
overproduce and sell at higher P
PRICE FLOOR AND MINIMUM WAGES
Student Task: Use the same economic theory of setting
Pf in the agricultural market to:
1.
2.
3.
Identify the impacts of the minimum wage laws on
the labour market
Outline the consequences of minimum wages on the
economy ( legal workers, illegal workers, cost of
production of producers, consumers)
Identify the impact of minimum wages on CS, PS
and welfare loss.
Use diagrams on the following slides to answer the
questions
LABOUR MARKET & PRICE FLOOR
WELFARE IMPACTS OF MINIMUM WAGES