1.4.1 Maximum Prices

Question 1

What is a maximum price

Answer 1

A legally imposed maximum price in a market that suppliers cannot exceed

Question 2

Who introduces a maximum price

Answer 2

Government

Question 3

What is the key aim of a price control

Answer 3

To improve affordability of a good or service to consumers, especially those on lower incomes

Question 4

Give examples of maximum prices

Answer 4

• energy price caps
• rent controls
• salary caps in sports

Question 5

How is a maximum price shown on a diagram

Answer 5

Draw supply and demand equilibrium as usual then draw a horizontal line below equilibrium to show maximum price

Question 6

What is the impact of a maximum price on suppliers

Answer 6

• due to the fall in price, producers are disincentivised from supplying the good due to lower profits now derived from the good
• this contracts supply

Question 7

What is the impact of maximum price on consumers

Answer 7

• due to the lower price consumers are able to afford to buy more
• demand expands

Question 8

What arises from maximum prices

Answer 8

Excess demand - there is a shortage of the good
Disequilibrium has arisen as demand is no longer equal to supply

Question 9

What are the pros of maximum prices

Answer 9

• those on lower incomes can now afford to buy the product due to lower prices
• prevents the exploitation of consumers
• helps to lower inflationary pressure in an economy as prices cannot go above a certain level
• can reduce inequality

Question 10

How do maximum prices prevent the exploitation of consumers

Answer 10

Due to monopoly power who may otherwise charge high prices

Question 11

Give an example of how maximum prices can reduce inequality

Answer 11

Max wages on highest paid workers

Question 12

What are the cons of maximum price

Answer 12

• unintended consequences (shortages)
• problems arise over how to allocate supply to demand
• producer surplus falls
• an illegal economy may emerge or sellers may find another way to charge

Question 13

What are the unintended consequences of maximum price

Answer 13

Shortages are likely to arise due to excess demand, which can lead to a misallocation of resources

Question 14

What is the effect of lower producer surplus

Answer 14

• Lower profits can lead to lower investment in the industry and possibly worsening customer service
• some producers may even leave the market, worsening shortages

Question 15

What does the impact of maximum price depend on

Answer 15

• how far below equilibrium the maximum price is set
• PED and PES
• government response to a shortage
• type of product

Question 16

Explain how impact depends on how far below equilibrium the maximum price is set

Answer 16

If it is not very far below equilibrium, consumers may not significantly benefit from lower prices

Question 17

Explain how the impact depends on PED and PES

Answer 17

More effective is both are elastic as both consumers and producers will be responsive to the lower price

Question 18

Explain how the government may intervene to prevent a shortage

Answer 18

Subsidies