Price regulation / restrictions

Readers question: Please tell me some products for which equilibrium price is not favourable for some producers and consumers which invite the state to impose price restriction.

The equilibrium price is the price determined in a free market; the price determined by the interaction of supply and demand.

sd

Under what conditions could this market price be unfavourable?

Volatile prices. Some agricultural markets could see very volatile prices due to changes in the weather and inelastic demand. The government could attempt to maintain an average / target price, which avoids these short term fluctuations.

inelastic

For example, a very good harvest could reduce the price of a food item. This low price (p2) would reduce incomes of farmers and could leave them with insufficient money for that year. In this case, the government could use a minimum price (perhaps buying some of the surplus and storing, e.g. see Buffer Stock)

In this case of a minimum price, consumers don’t lose out too much. If price of potatoes falls or rises 20%, it doesn’t make much difference to our living standards, but a fall in income of 20% for farmers could.

On the other hand, if prices rose too much because of a shortage, the government may be concerned that prices were too high and low income consumers might not be able to afford. In this case the government may use a maximum price to prevent prices going too high. The motivation for this is to ensure that all consumers can still afford the good. In developing economies, we may see maximum prices for food, in the developed world perhaps maximum prices for renting or transport. However the problem is that a maximum price may lead to shortages, queues and a black market.

maxprices

Maximum price of Max P leads to shortage – demand (Q2) greater than supply (Q1)

Very inelastic supply

If we have a good with a very inelastic supply, it gives firms / owners the potential to increase price significantly. But if the good is very important, the government may again use maximum prices. One example is rents. Supply of rented accommodation is inelastic, at least in short term. Landlords could use this shortage of accommodation to increase the price of rents and make more profit. In the First World War, the UK government introduced it’s first rent controls to prevent landlords increasing rents above a certain amount. The 1915 rent act restricted how much rents could rise during a period of zero house building during the war.

Goods with Externalities

For goods with negative externalities or goods considered demerit goods, the government may wish to increase the price above the market clearing price. For example, there was talk about a minimum price for cheap alcohol. The hope was that increasing the price of alcohol would help reduce issues related to binge drinking and alcoholism. In this case the market equilibrium price for cheap alcohol ignores the social costs of the good. The government is trying to set a price which gives a more socially efficient consumption level.

Usually, governments increase the market price by placing a tax on the good. In that way they discourage use of good, but also gain revenue. e.g. tax on carbon, tax on sugary drinks

Similarly, the government may seek to reduce the price of goods with positive externalities through subsidy or direct provision (e.g. health care / education)

Related pages

2 thoughts on “Price regulation / restrictions

  1. Equilibrium price cannot always be favourable to either suppliers of good and service and the consumers. In a situation like airpots in South Africa, its citizens would generally not afford the price it would cost for them to utilise the service but the government intervenes by paying out subsidies

  2. It is good for the government to intervene because it creates affordable prices to consumers, just like in south africa the government intervenes so that the consumers can afford to pay electricity and also regulate the price ESKOM sets(monopolist)

Leave a Reply

Your email address will not be published. Required fields are marked *