Max and Min Price Flashcards
1
Q
Maximum Price definition
A
a legal limit on the highest price that can be charged.
2
Q
Maximum Price facts
A
- Imposed below the normal equilibrium price.
- Government considers the equilibrium price to be too high.
- Also called a “price ceiling”.
- Has no effect if set at or above equilibrium.
- Examples: Rent controls (housing), Staple foodstuffs (e.g. bread, rice), Transport fares (e.g. public bus transport)
Utilities (e.g. electricity, water).
3
Q
Advantages of Maximum price
A
- Lower prices for merit goods and necessities goods prices: increases consumption and positive externalities, especially useful to low income earners..
- Reduces monopoly power: especially useful when applied to utilities where there is a lack of competition.
4
Q
Disadvantages of Maximum price
A
- Shortages: excess demand at the lower price, means rationing will need to occur.
- Costly to Govt: may need to supply the shortage itself or provide subsidies to firms to supply the shortage.
- Queuing: waste of time, opportunity cost.
- Black markets: buy at the maximum price and re-sell at a higher price to those unable to buy it.
- Lower prices for everyone: the rich benefit from lower prices too.
- Market forces are distorted: unable to reach equilibrium.
- Less investment: lower prices reduce profits, which discourages investment.
- Deadweight welfare loss: economic inefficiency.
5
Q
Maximum Price Evaluation
A
- Must be set below equilibrium to have any effect.
- Involves the government making a normative judgement about the equilibrium price and a “better” maximum price.
- Interferes with the signalling, rationing and incentive functions of the price mechanism, which leads to inefficient outcomes.
- Open to political manipulation.
- More effective when used with other policies (e.g. subsidies).
- Overall impact depends on PED and PES (see next slide).
6
Q
Maximum price with Elastic PED and PES
A
Larger shortage
Large extension in demand.
7
Q
Maximum price with Inelastic PED and PES
A
Smaller shortage
Small extension in demand.
8
Q
Minimum Price definition
A
a legal limit on the lowest price that can be charged.
9
Q
Minimum Price facts
A
- Imposed above the normal equilibrium price.
- Government considers the equilibrium price to be too low.
- Also called a “price floor”.
- Has no effect if set at or below equilibrium.
- Examples: Demerit goods (e.g. alcohol, tobacco), Wages (e.g. minimum wage), Some imported goods (to help domestic producers)
10
Q
Minimum Price advantages
A
- Higher prices for demerit good: reduces consumption and lowers negative externalities.
- Higher wages: useful when applied to low paid jobs.
11
Q
Minimum Price disadvantages
A
- Surpluses: excess supply at the higher price, leads to greater resource use and scarcity.
- Costly to Govt: may need to buy up and store the surplus, which causes an opportunity cost.
- Black markets: poorer consumers may search for cheaper alternatives of a lower standard.
- Higher prices for everyone: the poor might be unable to afford the higher prices.
- Market forces are distorted: unable to reach equilibrium.
- Deadweight welfare loss: economic inefficiency.
12
Q
Minimum Price Evaluation
A
- Must be set above equilibrium to have any effect.
- Involves the government making a normative judgement about the equilibrium price and a “better” minimum price.
- Interferes with the signalling, rationing and incentive functions of the price mechanism, which leads to inefficient outcomes.
- Open to political manipulation.
- More effective when used with other policies (e.g. indirect tax).
- Overall impact depends on PED and PES (see next slide).
13
Q
Minimum Price with Elastic PED and PES
A
Larger excess supply
Large contraction in demand.
14
Q
Minimum Price with Inelastic PED and PES
A
Smaller excess supply.
Small contraction in demand.
