2. Governments can interfere with the market mechanism by… setting maximum prices (price ceilings) setting maximum prices (price ceilings) setting minimum prices (price floors) setting minimum prices (price floors) subsidising certain products or activities subsidising certain products or activities taxing certain products or activities. taxing certain products or activities.

3. Governments set maximum prices to… keep prices of basic foodstuffs low avoid exploitation of consumers by producers combat inflation Maximum Price above Pe??? Maximum Price below Pe???

4. Government sets a maximum price (P m ) below equilibrium price (P 0 ). At (P m ) consumers demand Q 2 > equilibrium quantity Q 0 Supply falls to Q 1, < than equilibrium quantity Q 0 Causes market shortage (excess demand) Q 2 - Q 1 (ab) Without price control, excess demand raises price until equilibrium is re-established. With price control something else must do the job. How to allocate quantity supplied (Q 1 ) between consumers Q 2 ?

5. This can be done in various ways… “First come first served” – queues/waiting lists. Informal rationing systems (eg limiting quantity sold to each consumer). Government introduce official rationing system by issuing ration tickets.

6. Some consumers willing/able to pay P 1 Tickets purchased at P m can make a profit of P 1 - P m

7. Fixing prices below the equilibrium (or market-clearing) price thus… creates shortages (or excess demand) prevents market mechanism from allocating available quantity among consumers stimulates black market activity

8. Maximum price (P m ) set below market-clearing price (P 1 ) Quantity: Q 1 - Q m. At P 1 - consumer surplus = P 1 DE At Pm - consumer surplus = P m DRU Gain B but lose A At P 1 - producer surplus = 0P 1 E. At P m - producer surplus = 0PmU. B transferred to consumer surplus. C disappears, since only Qm is produced and exchanged. Total welfare loss to society = A + C Deadweight loss

9. Usually found in agricultural markets for agricultural Stable demand, but supply subject to large fluctuations. Prices fluctuate and income unstable and uncertain. Minimum price below Pe??? Minimum price above Pe???

10. Government sets a minimum price of R40/kg. Q d now = 4 million kg Q s = 9 million kg Excess supply (surplus) of 5 million kg (ab).

11. Gov purchases surplus and exports. Gov purchases surplus and stores it Gov introduces production quotas to limit supply to quantity demanded at minimum price. Government purchases destroys surplus. Producers destroy the surplus.

12. Highly inefficient since… Consumers have to pay artificially high prices bulk of benefit accrues to large producers inefficient producers protected disposal of the market surpluses entails further cost to taxpayers

13. Government fixes minimum price (P m ) above equilibrium price. Q s falls to Q m At P 1 - consumer surplus = P 1 DE At P m – consumer surplus = P m DR Consumers lose A (to producers) & B (disappears). At P 1 – producer surplus = 0P 1 E At P m – producer surplus = 0P m RT Producers gain A from consumers) but lose C (disappears) Total deadweight loss to society = B + C