Download Unstable Markets - Surbiton High School

Inappropriate Prices
• Sometimes society thinks prices are too high or
too low for the good of everyone:
• Price too high: may be an essential item, or
deemed ‘good for society’ but inaccessible to
those on low incomes (merit goods or positive
externalities)
• Price too low: consumption may give rise to
negative externalities (eg. cigarettes) or sellers
can’t make a living (farming)
Minimum Prices
• Gov’t may intervene to raise agricultural prices and
farm incomes
• Price can’t go below the minimum
• Min price is always above the market price
Price
S
Min Price
Mkt Price
D
Qd
Qs
Excess supply
Quantity of
Wheat
Minimum Prices
• While aims may be noble, outcomes can be dire:
• Sellers have incentive to sell lots (they get a
higher price now); buyers don’t buy so much at
the higher price
• Excess supply must be dealt with:
- destroyed (waste of resources)
- ‘dumped’ on less developed countries for rockbottom prices (puts local producers out of
business)
Maximum Prices
• Gov’t may fix a maximum price to ensure more people
have access to the product
• Price cannot go above the maximum; eg max rent on
low-cost housing
• A maximum price is always below the market price
Rent
S
Mkt Rent
Max Rent
D
QS
QD
Shortage
Quantity of flats
Maximum Prices
• While the aims may be noble, the outcome may
be worse!
• Shortages occur and even less is available to
those who need it (sellers don’t want to sell for
such a low price – not worth their while)
• Black markets may develop (with accompanying
corruption & illegal activity)
Unstable Commodity Prices
• Prices may fluctuate too greatly to achieve
efficient allocation of resources
• Commodities are: raw materials used in
production of goods (eg. minerals, metals, or
agricultural goods)
• Large swings in price distort messages sent to
producers & consumers, often resulting in
under-production
• Makes it difficult for producers to earn a steady
income, plan & invest for the future
Agricultural Markets
• Although there is a long-term supply curve
determined by all the different suppliers
theoretical willingness to supply, actual
supply in any given season is fixed &
perfectly inelastic
• Because demand for food tends to be
relatively inelastic, a ‘good harvest’ where
prices fall, actually can mean falling
revenue & profits
Good Weather; Good Harvest
S actual
S planned
Price
- Revenues
tend to fall
P planned
P actual
D
Q
planned
Q
actual
Quantity of
Wheat
Bad Weather; Bad Harvest
S actual
S planned
Price
P actual
- Revenues
tend to rise
P planned
D
Q
actual
Q
Planned
Quantity of
Wheat
Price & Income Elasticity
• Over the long run, supply of agricultural
commodities has increased – technology, GM
foods, etc. – decreased relative price of food
• But demand for food is price inelastic so
revenues have fallen
• World incomes have risen, raising the cost of
living and relative standard of living of
production in the non-agricultural sector.
• But food is very income inelastic so farmers
have not seen the benefits & have fallen even
further behind on relative terms
Time Lags
• The length of the growing season means
there are time lags between farmers
making decisions about production and
actual changes in production
• This reduces the ability of producers to
respond to changes in the market and find
the best allocation of resources – it’s a
guessing game!
Buffer Stock Schemes
• Gov’t or relevant agencies establish a ‘band’ outside
which prices are not allowed to go – authorities will step
in to bring prices back into the band
Price
S1
S2
S
If prices rise above
max, gov’t sells
stock into the market
to bring the price
down
Max Price
Min Price
D
If prices fall below
min, gov’t buys up
stock to bring price
back up
Quantity of
Wheat
CAP (in a nutshell!)
• 1/3 of European Commission budget spent on
CAP
• Subsidies & min. prices cause food surpluses
which have to be dealt with
• Selling them into foreign markets cheaply
disrupts agricultural systems in other countries
• Destroying them represents a complete waste of
resources
• Many countries object to CAP and it is criticised
by the WTO