4.2 Price controls

Question 1

What are price controls?

Answer 1

Setting of minimum price or maximum prices by the government so that prices are unable to adjust to their equilibrium level determined by demand and supply.

Results in market disequilibrium –> shortages (excess demand) or surplus (excess supply)

Question 2

What are the consequences of a price ceiling for the market

Answer 2

1. A shortage exists because the govt will not allow the price to rise
2. Non-price rationing to distribute goods among possible users (e.g. first come first serve, coupons, favourism)
3. Underground market: involves buying at a legal price and then illegally reselling it at a price above the price ceiling . Arises when there are dissatisfied people who have not succeeded in buying the good because there was not enough of it, and are willing to pay more than Pc.

Question 3

Under allocation of resources and allocative inefficiency with a price ceiling.

Answer 3

1. condition for allocative efficiency: MB = MC
2. Optimal output level = Qe
3. Output level after price ceiling Qd
4. Qd < Qs
5. Also at Qs: MB > MC: the benefit that consumers get from the last unit of the good they buy is more than the cost of producing it, more should be produced.
6. Welfare loss: social surplus or welfare benefits that are lost to society because resources are not allocated efficiently.

Question 4

What is a price floor

Answer 4

The price that can be legally charged by sellers of the good must not be lower than the price floor.

It has to be set higher than the equilibrium price to be effective.

Question 5

What are the consequences of a price floor for the market

Answer 5

1. Surplus
2. additional cost for govt: govt buy and store surplus = burden on taxpayers and incurs storage cost

Question 6

Over allocation of resources and allocative inefficiency with a price ceiling.

Answer 6

1. condition for allocative efficiency: MB = MC
2. optimum output level = Qe
3. Output level with price floor: Qs
4. Qs > Qe
5. Also at Qs: MB < MC: the benefits that the consumers get from the last unit of the good they buy is less than the cost of producing it, less should be produced.
6. Welfare loss

Question 7

***** calculating effect of price ceiling + price floor 119 - 124

Question 8

What are minimum wages

Answer 8

It is the minimum price of labour that an employer must pay.

It guarantees adequate income to low-income workers who tend to be mostly unskilled.

Question 9

What are the consequences of minimum wages on the economy?

Answer 9

1. unemployment
2. illegal workers
3. misallocation of labour resources in the labour marke