Economics HL: Government Intervention & Price Control

Price minimum, price maximum, minimum wages

Why governments intervene in markets?

• Earn revenue for the government

• provide support to firms

• provide support to households on low incomes

• influence the level of production of firms

• influence levels of consumption of households

• correct market failure

• promote equity (equality)

Government Intervention (Micro Level)

• Price control (min and max)

• Taxes (direct and indirect - specific and ad valorent)

• Subsidies (producers & consumers)

• Direct provision of goods and services

• Consumer nudges

• Command & control regulations & legislations

Price Control

Prices which are imposed upon a market by the government so that the controlled price will prevail and not the equilibrium price.

Who is responsible for price control?

Governments & cooperative arrangements between firms

Price maximum definition

The government may set a price maximum, which then prevents producers from raising the price above it.

Why is price maximum set?

Protect consumers & they are normally imposed in markets where the product is a necessity or a merit good.

Another word for price maximum?

Why does excess demand in Pmax cause problems?

Shortages may lead to an emergence of a black market & queues developing.

Possible solutions to remove excess demand?

1. Shift demand curve to the left until a new equilibrium is reached. However, this would limit consumption of product, which goes against the point of imposing the max price.

2. Shift supply curve to the right until new equilibrium is reached, with more being supplied & demanded. 

3. Government could offer subsidies to firms to encourage production.

4. Government could start production itself.

Consquences of price max on markets

1. Shortages: Excess demand, but not enough supply

2. Non-price rationing: favouritism, queues, distribution of coupons

3. Underground (parallel) markets: Illegal markets where consumers are willing to pay high prices to the good

4. Underallocation of resources to the good

5. Negative welfare impacts: Welfare benefits lost by society due to allocative inefficiency.

Consequences of price max on consumers

Pro: Consumers are able to buy goods at lower price

Con: Some consumers remain unsatisfied since they didn’t get to buy the good at all due to shortages.

Consequences of price max on producers

Their revenues drop down

Consequences of price max on workers

Increase in unemployment

Consequences of price max on government

Gain political popularity

Price Minimum Definition

Government may set a price floor which then prevents producers from reducing the price below it.

Another name for price minimum?

Price floor

Why are price floors set?

• Attempt to raise incomes for producers of that government thinks are important (e.g. agricultural goods)

• Protect workers by setting a minimum wage to ensure that workers earn enough to lead a reasonable life

What excess is created with Pmin?

Excess Supply

Why does excess supply cause problems?

Producers will find out they have surpluses and be tempter to sell their excess supply for lower prices.

How is excess supply solved?

Government has to intervene and they’d normally eliminate excess supply by buying up the surplus products at Pmin.
Thus, shifting demand curve to the right to reach new equilibrium.
Government could then store surplus, destroy it, or sell it abroad

How to maintain price floor?

• Producers could be limited by quotas, restricting supply

• Government could attempt to increase demand for the product by advertising

Consequences of price floors on market

• Surplus: too much supply but not enough demand

• Government measures to dispose of surpluses: It costs to store surpluses, and there is additional costs to export

• Firm inefficiency: Firms with high cost of production dont face incentives to cut costs by using more efficient production methods because the high price offers them protection against low-cost competitors

• Overallocation of resources: too many resources are allocated to production of good

• Negative welfare impact: society would be better off if the good was produced less

Consequences of price floor on consumers

pay higher prices for the good

Consequences of price floor on producers

Revenue increases and become protected against low-cost competitors. However, they dont face strong incentives to become efficienct and are likely to go out of business if they’re producing inefficiently at high costs.

Consequences of price floor on workers

Gain employment

Consequences of price floor on government

burden to pay surplus, resulting in less government funds on other desirable activities in the economy

Minimum wages definition

A minimum price of labour usually set by the government to protect low-skilled workers and ensure they can achieve a minimum standard of consumption

Consequences of minimum wages

• labour surplus and unemployment

• misallocation of resources in the labour market

• misallocation of resources in the product market

• illegal workers: some workers may accept to work for wages below the legal minimum.

Consequences of minimum wages for workers

those who recieve the minimum wages benefit, however people become unemployed due to labour surplus

Consqueneces of minimum wages for firms

hiring unskilled workers & paying the minimum wages may be worse off due to higher costs of production

Consqueneces of minimum wages on consumers

supply shifts to left, higher P and lower Q, so consumers are worse off.