Government and the Market: Price Controls

Minimum Prices

• Definition: A minimum price is a price floor set by the government.
• Justification: Reasons for implementing minimum prices.
• Effects:
  • Surpluses occur because the quantity supplied exceeds quantity demanded (Qs > Qd).
  • The diagram illustrates surplus with areas marked as 'surplus'.
• Cost to the Government:
  • The government may incur costs related to purchasing the surplus.
  • Diagram shows cost calculation as area between points.
• Dealing with Surpluses: Strategies for managing excess supply.

Maximum Prices

• Definition: A maximum price is a price ceiling set by the government.
• Justification: Reasons for implementing maximum prices.
• Effects:
  • Shortages occur because the quantity demanded exceeds quantity supplied (Qd > Qs).
  • The diagram illustrates shortage with areas marked as 'shortage'.
• Dealing with Shortages:
  • Methods include first-come, first-served, random ballots, favoring certain customers, or rationing.
  • 'Underground' or 'shadow' markets may emerge.

Underground Markets

• Price Control Effect: Price ceilings can lead to underground markets.
• Equilibrium Price:
  • Without price controls, equilibrium is at Pe.
  • With controls, if dealers buy at Pg, the underground market price rises to Pb.
  • Diagram illustrates price levels (Pg, Pe, Pb) and quantities (Qs, Qd) on supply (S) and demand (D) curves.