2.7.3 - Governments in Markets - Maximum Prices

Question 1

Why are maximum prices put in place?

Answer 1

To protect low income consumers from prices rising in a market to a level they cannot afford.

Question 1

Define maximum price

Answer 1

A maximum price is a price set by the government to prevent the price of a good or service from rising above a fixed level.

Question 2

List the 8 impacts of maximum price (for rental housing)

Answer 2

• Quantity demanded increases
• Quantity supplied decreases
• Excess demand develops because the quantity demanded is greater than the quantity supplied
• The rationing function of price no longer works effectively as price cannot rise to clear the market.
• Other methods of rationing develop such as queuing, preferential customer selection, regulations, lottery schemes.
• Parellel markets develop
• The quality of rented housing falls
• Long term investment in rented housing falls

Question 3

State what the yellow shaded area represents

Answer 3

Consumer surplus

Question 4

State what the green shaded area represents

Answer 4

Producer surplus

Question 5

State what the orange shaded area represents

Answer 5

Loss of welfare from consumers who no longer buy the good and producers who leave the market.

Question 6

State the impacts of maximum price on consumers

Answer 6

• Consumers who buy the good at maximum price benefit because they pay lower than equilibrium price.
• Consumers who would’ve paid equilibrium price but could not purchase due to the shortage lose their consumer surplus.
• Consumers might lose out due to the time spend queueing for a good that is in short supply.
• Consumers may have to pay inflated parallel price markets.

Question 7

State the impact of maximum price on producers

Answer 7

• Loss in producer surplus due to reduced profits.
• Some producers will leave the market as they no longer become viable due to losing consumer surplus.
• Some producers benefit from selling in parallel markets at inflated prices.

Question 8

State the impact of maximum price on governments

Answer 8

• Governments have to set up and pay for the maximum price
• Tax revenue may be reduced due to lower sales in the market.
• Political benefits for price ceiling as it seems effective.

Question 9

State the impact of maximum price on welfare

Answer 9

Loss in welfare due to loss of consumer surplus of consumers who no longer buy the good and loss in producer from producers who leave the market.

Question 10

Draw the diagram for maximum price

Answer 10