2.7.2 PRICE CEILINGS- ROLE OF GOVERNMENTS IN MARKETS

starting from 2.7.0

How can Governments intervene in markets?

Price controls

Indirect taxes

Subsidies

Direct provision of services

Command and control regulation and legislation

Consumer nudges

Why do Governments want to intervene?

earn government revenue

support firms

support households on low incomes

influence the level of production

influence the level of consumption

correct market failure

promote equity

GST

goods and services tax

VAT

value added tax

purpose of indirect tax

produce revenue to finance government spending, reduce consumer consumption of harmful goods

indirect tax

A tax imposed on a good or service; it is typically paid to the government by the producer or supplier and is considered a cost of production.

Excise tax

imposed on the expenditure of certain goods (imposed on inelastic PED)

specific tax

fixer dollar amount imposed on each unit of good

Ad valorem tax

greater price, the greater percentage of tax imposed

direct tax

A tax imposed directly on individuals or entities based on their income, property, or wealth. It is not passed on to another party.

Examples of direct tax

personal income tax. corporate income tax

demerit good

Goods that have negative effects when consumed and cause negative externalities of consumption.

market failure

occurs when markets fail to allocate resources efficiently, and community surplus is not maximised

merit good

A good that has positive externalities or benefits society as a whole, such as education or healthcare, often provided by the government to ensure equitable access.

price ceiling

Maximum price set below the equilibrium price to prevent producers from overcharging. done to protect consumers. common for essentials like rent or food.

why set price ceilings?

increase consumption of the good or service.

reduce the price of certain goods or services for low-income consumers.

prevent exploitation by monopolies

consequences of price ceilings

It produces shortages.

It generates a rationing problem.

It promotes the creation of parallel (black) markets.

It eliminates allocative efficiency and generates welfare loss.

There are consequences for market stakeholders.

calculate shortage

distance between quantity demanded and quantity supplied at the set price

why do price ceilings create shortages?

Price ceilings create shortages because they set a maximum price below the equilibrium price. This leads to increased demand and decreased supply, as suppliers are less willing to produce at a lower price. Consequently, the quantity demanded exceeds the quantity supplied, resulting in a shortage of the product.

Quantity demanded by old high-paying consumers + more quantity demanded by new cheap ppl

non-price rationing methods (not rationed by price anymore!!)

• People line up and wait their turn to buy the good, and only those who arrive first will be able to do so.

• Coupons are distributed between the interested buyers so that they can purchase a fixed amount of the good in a given time period.

• sellers use favouritism

parallel market

is a market where buying and selling transactions are unrecorded, and are usually illegal.

why do price ceilings create black markets?

richer consumers who were willing and able to purchase the good at a high price now cannot because of the shortage

producers who could’ve sold higher, now cannot sell legally

price for product between Pmax and Pequal

What are the consequences of price ceilings for consumers?

Some consumers of the good are better off and some are worse off. Those who get to buy the good at a lower price than before are better off. Those who do not get to consume it at any price at all because of shortages or rationing are worse off.

What are the consequences of price ceilings for producers?

Producers now sell a smaller amount of the good than before and receive a lower price for it. Their total revenue falls after the price ceiling is imposed, therefore they are worse off.

consequences of price ceilings for workers?

As the size of the market is reduced and fewer units of the good are sold, it is probable that workers will be fired in this market and unemployment will increase. Thus, those workers will be worse off.

consequences of price ceilings for governments?

Government does not have a revenue or a cost from this specific policy. However, it may gain political popularity from those consumers who get to consume the good at a lower price than before.

Solutions to maximum price control consequences?

grant subsidies to increase supply

producing the shortfall quantity of the good itself to meet the total demand

store product before setting the price ceiling, then release supply when needed
**subsidies have opportunity cost