maximum prices

Maximum prices

A maximum price is a price set by government, above which the price is not allowed to rise. To be effective the maximum price needs to be set below the free market equilibrium price

What is the purpose of a maximum price

Could be used to lower the price of a good that creates a positive externality The reduction in price should price consumers in to the market and increase the consumption

Examples are

MOT

Train tickets

What does a maximum price create shown on the diagram

It creates a shortage, as their is more demand than there is supply

What is the impact of maximum price on consumer surplus

Consumer surplus increases as the price falls This makes the gap between the market price and the price consumers are willing to pay larger

What is the impact of maximum price on producer surplus

Producer surplus decreases as the price falls

This makes the gap between the market price and the

price producers are willing to sell for smaller

Remember - producer surplus is essentially profit, so

this means profit is falling

■ Profit = revenue - costs → the maximum price will reduce

revenues of producers

What are the problems with maximum prices

A maximum price will create a shortage and

disequilibrium will need to be maintained

◻ Some consumers may be prepared to pay above the

maximum price to get the goods that they want

Potential for a black market

◻ Normally with a shortage, the price rises and acts

as a rationing device, so that the market clears

With a maximum price it loses its rationing ability, so

a different form of rationing must be adopted