[FEB] - Maximum + Minimum Prices

Question 1

What is a maximum price ?

Answer 1

• a maximum price is a price set by a government or controlling authority to prevent the price of a good or service from rising above a fixed level

Question 2

Reasons for maximum prices

Answer 2

• to protect low-income consumers from prices rising in a market to a level they can’t afford

Question 3

What type of goods are maximum prices typically placed on ?

Answer 3

• goods that governments believe all people in society should be able to afford
• eg housing, basic foods, healthcare and education

Question 4

Examples of goods maximum prices may be placed on

Answer 4

• housing
• basic foods
• healthcare
• education

Question 5

Why is there a disequilibrium after maximum prices are put in place ?

Answer 5

• prices fall, so demand increases by law of demand
• producers are less willing to/ able to supply goods at a lower price
• so Qd > Qs ( there is excess demand )
• and the rationing function fails, because legally producers can’t raise their prices to price some consumers out
• so a black market may be created

Question 6

What is a consequence of maximum prices causing excess demand ?

Answer 6

• black market may be created

Question 7

Why does rationing function fail after maximum prices are set ?

Answer 7

• legally producers cannot increase prices
• so consumers can no longer be ‘priced out’

Question 8

What other methods of rationing develop as a result of the rationing function failing ?

Answer 8

• queueing
• preferential consumer selection
• regulations
• lottery scheme

Question 9

What is queueing ?

Answer 9

• first come, first served rationing method

Question 10

What is preferential consumer selection ?

Answer 10

• favouritism
• eg landlords renting to tenants they know / races they prefer

Question 11

What are regulations as a rationing method ?

Answer 11

• government introduces legislation to ensure certain groups have access to goods in high demand
• eg landlords are forced to prioritise families

Question 12

What are lottery schemes as a rationing method ?

Answer 12

• random selection
• eg randomly choosing your tenants

Question 13

Why do parallel markets develop ?

Answer 13

• consumers + producers try to find their way around price controls

Question 14

How do consumers + producers try to find their way around ceiling price controls ?

Answer 14

• developing parallel markets

Question 15

What happens to quality of goods with price ceilings ?

Answer 15

• quality of good declines
• because producers lack the funds to maintain their goods as well as they could at the equilibrium price

Question 16

Why does the quality of goods with a price ceiling decrease ?

Answer 16

• because producers lack the funds to maintain their goods as well as they could at the equilibrium price

Question 17

What happens in the long term as a result of price ceilings ?

Answer 17

• new investment
• because market isn’t as profitable as it would be without the maximum price

Question 18

Why do price ceilings result in new investment in the long term ?

Answer 18

• because market isn’t as profitable as it would be without the maximum price

Question 19

Name 4 stakeholders impacted by maximum prices causing excess

Answer 19

1. Consumers
2. Producers
3. Governments
4. Welfare / society

Question 20

What is the impact of maximum prices on consumers who buy the good / service at the maximum price?

Answer 20

• they benefit
• because they pay a lower price than the equilibrium price

Question 21

What is the impact of the maximum prices on consumers who would have paid the market price but cannot buy the good at the maximum price, because they were ‘supplied out’ ?

Answer 21

• they lose their consumer surplus
• so there is consumer welfare loss

Question 22

Why may consumers lose from the price ceiling other than being ‘supplied out’ ?

Answer 22

• time spent queueing for a good that is in short supply
• may encounter extra regulations resulting from the price ceilings

Question 23

What may some consumers do as a result of being supplied out ?

Answer 23

• enter the parallel market
• where they may have to pay an inflated price and risk breaking the law

Question 24

What is the impact of price ceilings on producers ?

Answer 24

• producers lose producer surplus
• less revenue + profit from selling their goods / services

Question 25

What may some producers do after a maximum price ?

Answer 25

- leave the market - and their producer surplus disappears - some fringe producers enter the parallel market and profit from selling their goods illegally

Question 26

What happens to producer’s producer surplus if they leave the market after a maximum prices ?

Answer 26

- it disappears

Question 27

What is the impact of maximum prices on governments ?

Answer 27

- governments incur the cost of setting up + enforcing maximum prices - loss of tax revenue as a result of lower market sales - could have political benefits ( appears to be an effective policy for reducing prices )

Question 28

What is the impact of maximum prices on society / welfare ?

Answer 28

- maximum prices lead to consumer + producer welfare loss

Question 29

Why do maximum prices result in consumer welfare loss ?

Answer 29

- because consumers who don’t buy the good anymore lose their consumer surplus

Question 30

Why do maximum prices result in producer welfare loss ?

Answer 30

- producer surplus of the producers who leave the market disappears

Question 31

What is a minimum price ?

Answer 31

- a minimum price is a lower limit set by the government or controlling authority to stop the price of a good / service from falling below a certain level

Question 32

Reasons for minimum prices

Answer 32

- to protect producers in markets - often the case in agricultural markets

Question 33

Which markets often have minimum prices ?

Answer 33

- agricultural markets

Question 34

Why do governments often place minimum prices on agricultural markets ?

Answer 34

- governments look to support farmers - and protect the food supply - strong lobby groups

Question 35

What happens in the market as a result of minimum prices ?

Answer 35

- there will be a disequilibrium

Question 36

Why will there be a disequilibrium in a market when a minimum price is placed ?

Answer 36

- prices rise, so demand falls by law of demand - so Qs > Qd, there is excess supply - rationing function of price fails because the price legally can’t decrease to ‘price in’ consumers - government buys the excess surplus

Question 37

Why does the rationing function fail after a minimum price is placed ?

Answer 37

- there is a maximum price, so legally the price of goods / services cannot be decreased to ‘price in’ consumers

Question 38

What does the government do as a result of the excess supply caused by minimum prices ?

Answer 38

- buys the excess supply

Question 39

Which stakeholders are impacted by minimum prices ?

Answer 39

- producers - consumers - government - society / welfare

Question 40

What is the impact of minimum prices on consumers ?

Answer 40

- lose consumer surplus as they pay a higher price

Question 41

What is the impact of minimum prices on producers ?

Answer 41

- gain producer surplus

Question 42

What is the impact of minimum prices on the government ?

Answer 42

- must buy the surplus - cost of doing something with the surplus - if government exports excess supply, producers in their country will lose

Question 43

What is the impact of minimum prices on society / welfare ?

Answer 43

- opportunity cost of inefficient government spending - inefficient producers may be brought into the market - minimum prices can lead to a misallocation of resources ( huge surpluses develop at the expense of reduced production in other markets ) - cost of waste, if excess supply is destroyed because it cannot be sold