1.4.3 Maximum and minimum prices Flashcards
Maximum prices (price ceiling)
Where the government sets the price level below equilibrium.
What is the main reason why price ceilings are used?
Price ceilings are used by the government to ensure that vital goods and accessible to all consumers and so that the price does not exclude those with low incomes.
How do maximum prices affect supply and demand in the economy?
With maximum prices, there is excess demand and a shortage of supply.
- This means remaining supply needs to be rationed out.
Give an example of maximum prices (price ceilings)
Rent caps are used to set a maximum price in the rental market. These have been used historically in the UK and during the 2019 General Election, the Labour Party proposed to bring them back, particularly in London.
Advantages of price ceilings
- Maximum prices can help to increase fairness, by allowing more people the ability to purchase certain goods and services.
- They can also be used to prevent monopolies from exploiting consumers.
Disadvantages of price ceilings
- As demand is higher than supply, some people who want to buy the products aren’t able to.
- Governments may need to introduce a rationing scheme to allocate the good.
- Excess demand can lead to the creation of a black market for a good.
Minimum prices (price floors)
Where the government sets the price level above equilibrium.
What are some of the main reasons why price floors are used?
Price floors are used by the government to ensure that suppliers get a fair price.
- To support industries that are vulnerable to volatile price changes.
- Minimum prices can also work well restrict monopsony power as they will provide a guaranteed price for suppliers and ensure that a firm that is a monopsony buyer cannot keep negotiating lower and lower prices.
In order for minimum prices to work, what must the government do?
To make a minimum price for a good work, the government must purchase the excess supply at the guaranteed minimum price.
The goods bought by the government is either stockpiled or destroyed.
Give examples of minimum prices (price ceilings)
- The EU’s Common Agricultural Policy (CAP) involves the use of a guaranteed minimum price for many agricultural products.
- US Milk Industry: Between 1930 to 1983 the US Government imposed minimum prices on milk. Volatile milk prices meant that dairy farmers risked going bankrupt – a key provider of employment. The minimum prices introduced ensured that dairy farmers could meet their costs of production.
- Alcohol in Scotland: In May 2019, Scotland became the first country in the world to place a minimum price per unit of alcohol. This was introduced as a deterrent, with the aim of tackling Scotland’s drinking culture. Retailers have to charge a minimum price of 50p per unit. For example, a three-litre bottle of Frosty Jack cider went up from £4.70 to £11.25
Advantages of minimum prices (price floors)
- Producers have a guaranteed minimum income which encourage investment.
- Stockpiles can be used when supply is reduced (e.g. due to bad weather) or as overseas aid.
Disadvantages of minimum prices (price floors)
- Consumers will be paying a higher price than the market equilibrium.
- Resources used to produce the excess supply could be used elsewhere – there’s an inefficient allocation of resources.
- Government spending on a minimum price scheme could be used in other areas – schemes may have a high opportunity cost.
- Destroying excess goods is a waste of resources.
Price controls and market failure
Maximum prices are used in response to market failure occurring in the free market, as the price can be too high and exclude some consumers (particular concern if the good is essential – medicine, food etc.)
Additionally, market failure can occur if the price becomes too low and many firms exit the market (as part of the signalling function of the price mechanism).
How are minimum prices used in the labour market?
National Minimum Wage (NMW)
