Question

Instructions The textbook describes in Chapter 3 price controls, which includes price ceilings and price floors. For this assignment, select an example of an effective price ceiling or price floor, you can choose the examples provided in the textbook like rent control, agricultural supports, minimum wage or from other sources. In this 1-2 page paper, analyze what happens when a price ceiling or price floor is enacted. Who benefits and who loses from enacting the price control? Why would the government choose to enact the particular price control? What are some unintended consequences as a result of the enacted price control?

Answer 1

Answer to the question:

The major approaches to price control mainly include the strategies of price ceiling and price floor. Price ceiling or price floor refers to a situation, when the price of a commodity is charged more or less than the price as fixed by the market forces.

Now to explain the effects and consequences of price control, let us consider an agricultural market of rice and let us further assume that the strategy of price floor is imposed in this particular market. As given in the following figure 1; the curve D₁ represents demand curve for rice and S₁ represents the supply curve of rice. As shown in the following figure, without government intervention, the equilibrium price and quantity is determined by the market forces at the point E₁. Now let us suppose that the government introduced the plan of price floor in this particular market. This strategy of price floor is basically targeted to keep the market price at P₂ (above the equilibrium price p₁, this is because there is no point in setting the price as a measure of price floor below the equilibrium price. The market force itself will not allow the price to fall below the equilibrium price). Now with this price P₂, it is seen that there exists excess supply of rice in comparison to its demand. So, there will be a natural tendency in the part of market price to fall below P₂. But the government will not allow the price to fall below P₂ under the price floor mechanism. So, the government will purchase this excessive part of supply (D₂S₂); so that there exists no excess supply or in other words, market demand gets equal with market supply. Finally, at the price P₂, the equilibrium output will be equal to OY₂.

Figure 1: Effects of Price Floor in Agricultural market S1 D2 S2 P2 PRICE E1 P1 D1 0 Y2 Y1 OUTPUT

In general, when the different mechanisms of price control are imposed on a certain market; the equilibrium output is determined either more or less than the equilibrium output set by the market forces. This happens because, under different mechanisms of price control, price in a market is generally set either above or less than the equilibrium price determined by the market forces. With the fluctuations of price level, automatically the level of equilibrium output tends to fluctuates.

It is very much difficult to identify the potential gainers and losers of different price control mechanisms of different markets instantly. Because the potential gainers and losers of different price control mechanisms tend to vary with the structure and type of the markets. For example, the price control in an agricultural market is introduced with an objective to benefit the farmers. But during this process, the government losses a substantial part of its revenue for its role in price control mechanisms.

Governments introduced different types of price control in different markets for various reasons. As we have explained the effect of price control in an agricultural market, let us explain it further. Government imposed price floor or price ceiling in agricultural market to protect the farmers from potential losses. The agricultural market is often characterised by its nature of volatility. The agricultural prices tend to decrease in the cases of overproduction or due to different types of trade restrictions. In these situations, the farmers face huge losses. Thus to protect the farmers form these types of losses, government introduces different types of price control mechanisms.

However, mechanisms of price control often provide some intended results. Let us consider the case of price floor in agricultural market. Although the measure of price floor protects the farmers from their losses but it is often done at the cost of higher burden on taxpayers and higher expenses of consumers. This is because, often government initiated price floor strategy with their collected revenue (that is tax). Moreover, with the increase in prices of agricultural commodities, consumers pay more prices for their consumption.

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