1.4.1 Maximum Prices Flashcards
What is a maximum price
A legally imposed maximum price in a market that suppliers cannot exceed
Who introduces a maximum price
Government
What is the key aim of a price control
To improve affordability of a good or service to consumers, especially those on lower incomes
Give examples of maximum prices
- energy price caps
- rent controls
- salary caps in sports
How is a maximum price shown on a diagram
Draw supply and demand equilibrium as usual then draw a horizontal line below equilibrium to show maximum price
What is the impact of a maximum price on suppliers
- due to the fall in price, producers are disincentivised from supplying the good due to lower profits now derived from the good
- this contracts supply
What is the impact of maximum price on consumers
- due to the lower price consumers are able to afford to buy more
- demand expands
What arises from maximum prices
Excess demand - there is a shortage of the good
Disequilibrium has arisen as demand is no longer equal to supply
What are the pros of maximum prices
- those on lower incomes can now afford to buy the product due to lower prices
- prevents the exploitation of consumers
- helps to lower inflationary pressure in an economy as prices cannot go above a certain level
- can reduce inequality
How do maximum prices prevent the exploitation of consumers
Due to monopoly power who may otherwise charge high prices
Give an example of how maximum prices can reduce inequality
Max wages on highest paid workers
What are the cons of maximum price
- unintended consequences (shortages)
- problems arise over how to allocate supply to demand
- producer surplus falls
- an illegal economy may emerge or sellers may find another way to charge
What are the unintended consequences of maximum price
Shortages are likely to arise due to excess demand, which can lead to a misallocation of resources
What is the effect of lower producer surplus
- Lower profits can lead to lower investment in the industry and possibly worsening customer service
- some producers may even leave the market, worsening shortages
What does the impact of maximum price depend on
- how far below equilibrium the maximum price is set
- PED and PES
- government response to a shortage
- type of product
Explain how impact depends on how far below equilibrium the maximum price is set
If it is not very far below equilibrium, consumers may not significantly benefit from lower prices
Explain how the impact depends on PED and PES
More effective is both are elastic as both consumers and producers will be responsive to the lower price
Explain how the government may intervene to prevent a shortage
Subsidies
