2.11 Government Intvention (Price Controls)

Question 1

What are the advantages of using a minimum price?

Answer 1

• A price floor can discourage consumption of potentially harmful low quality products by increasing price (demerit goods/negative externalities)
• A minimum price can be used to secure a higher price to be paid for scarce non-renewable resources, to restrict quantity demanded -> may conserve scarce resources
• Can be used to increase prices of agricultural products -> reduce income inequality
• National minimum wage (NMW) will increase wages of lowest paid workers and may increase incomes in low income households -> reduce inequality
• Minimum prices tend to affect those markets where price is unacceptably low (inequitable); markets where price/wage is much higher are relatively unaffected
• NMW may offset the market power (wage setting power) of large scale monopsony (single buyer) employers - > minimum wage may increase quantity of labour employed

Question 2

What are the disadvantages of using a minimum price?

Answer 2

• Could lead to an inefficient allocation of resources if the market was not failing -> results in a deadweight loss of social welfare
• Provides incentives for illegal markets to form -> prices in illegal markets will fall below the legal minimum
• If minimum price is supported by guaranteed buying, with excess supply being bought by the good needs to be stored or destroyed. There is an opportunity cost associated with spending by government and scarce resources used to administer the scheme
• The market may become more profitable for firms in less competitive product markets as the firms will only produce enough to meet demand and make greater profits by doing so
• Higher price for consumers converts some consumer surplus to additional producer surplus -> redistribution effect from consumers to producers, may reduce standard of living

Question 3

What are evaluative opportunities for a minimum price?

Answer 3

• The size of a surplus (excess supply) will depend on the PED and PES of the product -> smaller surplus if PED and PES are inelastic
• The associated loss of welfare may be socially more acceptable if there is an increase in prices of products that are deemed socially undesirable -> may offset the effects of a failing market
• If the surplus is larger (due to elastic demand and supply), the costs associated with storage of surplus perishable farmed product will be far greater (based on government buying of the surplus)
• An indirect tax may be a more effective market based intervention - there would not be a surplus and no associated waste in production
• Minimum prices may be a more effective intervention in markets where buyers are exerting monopsony power as this may increase prices without a fall in quantity supplied

Question 4

What are the advantages of using a maximum price?

Answer 4

• Price is not allowed to rise above an affordable price for consumers which may give more equitable access to goods
• May offset significant price setting power by monopoly sellers
• Can provide a more equal distribution of merit goods if the associated system of rationing allows fairer access to to those most in need

Question 5

What are the disadvantages of using a maximum price?

Answer 5

• Possible inefficient allocation of resources, because excess demand is created by interfering with the free-market price mechanism
• An alternative form of rationing is often required such as queuing, limits on households, waiting lists etc. -> may involve additional use of scarce resources -> possible opportunity cost
• Provides incentives for illegal markets to form -> prices in illegal markets exceed the legal maximum
• The market supply may become less profitable for firms -> may lead to less investment and decrease supply in the long-term

Question 6

What are evaluative opportunities for a maximum price?

Answer 6

• The size of the shortage (excess demand) depends on the PED and PES of the product
• The associated loss of welfare may be socially more acceptable if there is a more equitable set of prices without a significant fall in consumption
• More price elastic supply and demand will lead to a larger shortage and the costs associated with rationing will be far greater
• Subsidies may be a more effective market based intervention by enduring basic products are more affordable and increasing quantity supplied too
• Maximum prices may be more effective when suppliers are exerting monopoly power to exploit consumers, as this may reduce prices without a fall in quantity consumed -> excessive producer surplus will be converted to consumer surplus which may be deemed more equitable

Question 7

What is a buffer stock scheme and what is its purpose?

Answer 7

A buffer stock scheme is a price stabilisation scheme, where the government intervenes as a seller and buyer of the good, to stabilise price

Question 8

What is the purpose of a minimum price?

Answer 8

To ensure the price of a good/service is not unacceptably low, by setting a legally enforced price floor

Question 9

What is the purpose of a maximum price?

Answer 9

To ensure the price of a good/service is not too high, by setting a legally enforced price ceiling