GOVERNMENT INTERVENTION PRICE CEILING & PRICE FLOOR Syllabus Outcomes: Explain why governments impose price ceilings/ price floors Give examples including food price controls and rent controls Draw diagrams to show price ceilings/ price floors and analyze its impacts on the market outcomes Examine the consequences of the price ceiling /price floors

P RICE C ONTROLS Refer to setting of minimum or maximum prices by the government or private organizations so that prices are unable to adjust back to equilibrium levels determined by the forces of D+S Price controls result in disequilibrium and therefore in shortages (excess D) or surpluses (excess S)

W HAT IS A P RICE CEILING ? Also known as maximum price - where the price charged by sellers cannot be higher than the legally set price ceiling. This price is normally set BELOW equilibrium price and therefore results in disequilibrium leading to shortages in S or excess D at the lower prices

O UTCOMES OF P RICE C EILING

I MPACTS OF P RICE CEILINGS ON THE MARKET Lower P charged for the product Shortage of S / excess D Increase in Qd at lower prices Less Qs supplied due to lower P

C ONSEQUENCES OF FOR THE ECONOMY Consequences of P Ceiling Supply shortages Black markets Allocative inefficiency Non price Rationing Negative welfare impacts

Waiting in line - sell to those who come first Distribution of coupons – limits amount of goods that can be bought at a time Favouritism – sell to preferred customers Selling in illegal markets goods at high prices than those set in the legal market Non –price rationingBlack markets

Producing lower quantities – not supplying what society wants Social welfare = consumer and producer surplus Society is worst off because consumer surplus and producer surplus are both reduced due to P ceiling leading to dead weigh loss (welfare loss) consumers are not getting enough of the good and producers are not selling enough either Qs < Qd Allocative inefficiency Negative impacts on social welfare

Consumer Surplus (CS) after Pc e Producer Surplus (PS) after Pc CS = a+ b PS = c+d+e Social Surplus = CS + PS = a+b+c+d+e Before P ceiling

R EAL LIFE EXAMPLES OF PRICE CONTROL Price ceilings are commonly used for goods that are considered to be neccesities to ensure that they remain affordable for consumers Examples : Rent and food markets Student task : Draw a diagram of the rental market showing the imposition of price ceiling Identify the likely consequences on the market

C ONSEQUENCES OF RENT CONTROLS Rental houses become affordable /cheaper Shortage of housing as the Qd at the lower Pc is higher than quantity available. Long waiting list for interested tenants Black market – where people sublet their apartments to others at higher P than Pc Rented apartments become run-down and poorly maintained as it becomes unprofitable for landlord to spend on their properties Less people will be willing to buy properties and rent them out due to the low rent return.

W HAT IS A P RICE F LOOR ? Also known as minimum price - where the price charged by sellers cannot be lower than the legally set price floor This price is normally set ABOVE equilibrium price and therefore results in disequilibrium leading to shortages in D or excess S at the higher prices

O UTCOMES OF P RICE F LOORS

I MPACTS OF P RICE F LOOR ON THE MARKET Higher P charged for the product Shortage of D / excess S Increase in Qs at higher prices Less Qd due to higher P

C ONSEQUENCES OF FOR THE ECONOMY Consequences of P Floor Surplus Government measures to deal with the surplus Allocative inefficiency Firms inefficiency Negative welfare impacts

C ONSEQUENCES OF PRICE FLOOR G OVERNMENT MEASURES TO DEAL WITH SURPLUS Price floor result in surpluses due to higher P causing a fall in Qd ie Qs>Qd. As result government must decide on how to best deal with the surplus to maintain Pf. Options include: 1. Buy surplus and store it – problem: storage cost 2. Buy surplus and export it – problem may need to give subsidy to suppliers if P higher than overseas – again costly for government 3. Sent surplus as AID to poor countries

F IRMS INEFFICIENCY Refer to firms that produce at higher P than market equilibrium P, or produce quantities of goods that does not reflect what society wants. This means firms either under produce or overproduce. In the case of price floors firms overproduce and sell at the higher P and have no incentive to cut costs because they are guaranteed higher Pf. This leads to inefficiency

A LLOCATIVE INEFFICIENCY Where too much is allocated by firms to the production of the good resulting in larger than optimum (best) quantity being produced. Quantity produced = Qs Optimum quantity = Qe

R EAL LIFE EXAMPLES OF PRICE FLOORS Governments commonly use price floors in 2 markets: a. The product market (agricultural) b. The resource market (labour/ workers) WHY??? for 2 reasons: 1. Support incomes for farmers by offering Pf higher than Pe to guarantee certain income levels. 2. Protect low skilled, low wage workers by offering them minimum wages above market levels to ensure adequate income levels

P RICE F LOOR IN A GRICULTURAL M ARKET

W ELFARE I MPACTS OF P RICE F LOOR a PS after Pf CS after Pf f Increase in social surplus = CS + CP after Pf

Government spending on the extra surplus = Pf x (Qs – Qd) Society loses because gov’t uses taxes to buy surplus instead of spending on other goods like education and health

W ELFARE IMPACTS OF PRICE FLOORS CS is reduced to (a) from (a+b+c) because they pay higher P and buy less Q PS is increased to (b+c+d+e+f) from (d+e) because they sell at higher P and make more goods Social Surplus increases by area (f) Society welfare loss (deadweight loss)= green rectangle because government spends taxes on buying surplus rather than on providing services such as health and education. Government spending increases – pressure on the budget Misallocation of resources because producers overproduce and sell at higher P

P RICE FLOOR AND MINIMUM WAGES Student Task: Use the same economic theory of setting Pf in the agricultural market to: 1. Identify the impacts of the minimum wage laws on the labour market 2. Outline the consequences of minimum wages on the economy ( legal workers, illegal workers, cost of production of producers, consumers) 3. Identify the impact of minimum wages on CS, PS and welfare loss. Use diagrams on the following slides to answer the questions

L ABOUR M ARKET & P RICE FLOOR

W ELFARE I MPACTS OF M INIMUM W AGES