LS20- Max and Min Prices

Question 1

Maximum price

Answer 1

Fixed price (price ceiling) enacted by the government usually set below the equilibrium price.

Question 2

What does a maximum price do?

Answer 2

Increases the affordability of necessity goods/services

Price decreases from P1 to Pmax
Extension in demand- excess demand
Deadweight welfare loss (triangle left of previous equilibrium)

Question 3

Maximum price impacts on key stakeholders

Answer 3

Consumers
- some benefit from lower prices- greater affordability hence rise in consumer surplus
- large chunk of consumers can’t access the goods at all (as displayed by the excess demand)- they may be forced to source alternative supply by means of smuggling or sourcing a black market

Producers
- contraction of supply, fall in producer surplus, may have to change the goods or services they are producing

Governments
- some utility gained as a portion of consumers are hitting their key goals
- may be concerned about the other impacts of this policy, in particular its impacts on producers leaving the market as well as the large excess demand
- unintended consequences of a black market forming so may even subsidise firms to increase supply, but that bears a huge opportunity cost

Question 4

Minimum price

Answer 4

A fixed price (price floor) enacted by the government usually set above the equilibrium price.

• protects producers from price volatility especially farmers who are prone to natural disasters etc

Question 5

Minimum price impacts on consumers

Answer 5

• pay higher prices where consumer surplus is being eroded- quantity is lower, choice is lower
• for low income households, affordability decreases since minimum prices take a greater proportion of the income of the poor than they do of the rich and in that sense, their effect is regressive
• overtime, consumers will have to bear the cost of intervention buying; taxes will be higher to fund minimum prices, there may be cuts to other areas of government spending in the economy, the government might be borrowing money and thus paying debt interest on that borrowing which has a large opportunity cost e.g. money could have been used more productively elsewhere in the economy

Question 6

Minimum price impact on producers

Answer 6

Their effect depends heavily on if there is intervention buying or not. If there is, it is greatly beneficial to producers who are thriving due to a huge increase in revenue allowing them to survive in the market if there is price volatility.

Question 7

Minimum price impacts on government

Answer 7

In theory, governments will like minimum prices if their core goals are being reached such as protecting producers and keeping an industry going.

They may however be very concerned about the impact on consumers, especially the regressive impact. May be unintended consequences of a black market forming due to higher prices.

They will also be concerned about the intervention buying costs since they are bearing that excess supply- they may have to waste resources by destroying the excess supply or spend money on storing them (storage costs). May also be international relations issues if they dump excess supply overseas to another country for prices below the cost of production.