3) Price controls - MB Flashcards
what is price control?
a legal maximum or minimum price
what is price floor?
a legal minimum price
what is price ceiling?
a legal maximum price
what is are examples of price floor? (2 things)
- minimum wage
- alcohol minimum unit pricing
what is an example of price ceiling?
rent control
what does a maximum price do?
increases consumption, and therefore consumers’ utility, by making a good or service more affordable
if a maximum price is set above the equilibrium price, what happens?
it will have no impact
if the maximum price is set below the free market equilibrium price, what happens?
it leads to excess demand and a shortage
what does a minimum price do?
- a minimum price increases production, the price producers receive, and therefore producer profits
if a minimum price is set above the equilibrium price, what happens?
the free market equilibrium price it leads to excess supply and a surplus
if the minimum price is set below the free market equilibrium price, what happens?
it will have no impact
diagram:
where is the minimum price set?
set at P1 which is above the market clearing price of P0
what does the minimum price (set at P1 above the market clearing price of P0) incentivise producers to do?
increase production, which leads to Q2 being produced
Diagram for minimum price:
what does the increase in price mean?
means that fewer consumers can afford to buy the good or service, so only Q1 is consumed, this leads to a surplus of Q2-Q1
Diagram for minimum price:
what is the government expenditure on the diagram?
(may or may not be the case, this is the case for crops but not alcohol)
- The government would be paying the maximum price to producers for all their produce not sold on the open market, leading to the government expenditure of P1 *(Q2-Q1)
when may a minimum price be imposed on goods?
on a good that causes negative consumption externalities, which imposes an external cost on third parties which is not taken into account, and therefore is overconsumed
how does minimum price improve allocative efficiency?
the minimum price reduces consumption towards MPC=MSC which improves allocative efficiency
eg alcohol minimum pricing in scotland
diagram, maximum price:
where is P1?
a maximum price set at P1 is below the market clearing price of P0
diagram, maximum price:
why does production fall to Q1?
the maximum price is set at P1 below the market clearing price of P0 which disincentives producers and production falls to Q1
diagram, maximum price:
what does the reduced price mean?
that more consumers can afford to buy the good or service, so consumers demand Q2, this leads to a shortage of Q2-Q1
how does the maximum price improve equality?
the maximum price allows lower income consumers to now demand the product, as they are now able to afford to buy the good or service. This improved access improves equality
what are the advantages of maximum prices? (2 things)
1) cheap
2) reduces monopoly power
how are maximum prices cheap?
it is quick and cheap for government to impose maximum prices as a method of improving equality
how do maximum prices reduce monopoly power?
a maximum price limits a monopoly’s ability to profit maximise and exploit consumers
what are the disadvantages of maximum prices? (3 things)
1) shortages reduces consumption
2) rationing may ensue
3) black markets
how do maximum prices cause shortages that reduce consumption?
due to the shortage created some consumers, that are willing to pay more than the maximum price, are unable to buy it at all, lowering their potential utility
how could maximum prices cause rationing?
to overcome the shortage, the government may need to allocate rations to consumers, which as a non- market based solution fails to efficiently allocate scarce resources
how do maximum prices cause black markets?
the shortage may lead to a black market forming, and an opportunity cost of lost tax revenue
what are the advantages of minimum prices? (2 things)
1) encourages investment
2) stockpiles
how do minimum prices encourage investment?
the minimum income that producers receive incentivises them to invest
minimum prices cause stockpiles, how is this advantageous?
stockpiles can mitigate the impact of severe weather
what are disadvantages of minimum prices? (list 3 things)
1) lowers utility
2) high opportunity cost
3) allocative efficiency
how do minimum prices lower utility?
consumers’ utility will be lower because, due to the higher price, they will be able to afford to buy and consume less
how do minimum prices cause a high opportunity cost?
the opportunity cost of the government paying minimum prices is lower spending on other services such as healthcare or education
how do minimum prices cause allocative inefficiency?
the surplus production is evidence of allocative inefficiency; the government then has to decide whether to stockpile, destroy or sell the surplus abroad
why does a maximum price compare unfavourably to a subsidy?
maximum price fail to increase consumption as producers reduce production in response. It may therefore be necessary to subsidised production alongside a maximum price
why does a minimum price compare unfavourably to a tax?
both act to reduce consumption and perhaps reduce negative externalities, but the tax raises revenue whereas the minimum price does not. It would improve allocative efficiency more to impose a tax alongside the minimum price and hypothecate the revenue to mitigate the impact of negative externalities
