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Maximum & Minimum prices
- 1. Maximum & Minimum Prices Lower 6th Micro Government Intervention
- 2. Maximum Prices Maximum & Minimum Prices Mr O’Grady
- 3. Maximum Prices Maximum Prices: A limit or cap on a price set by a government or an organisation The cap must be below the free market equilibrium price to have any effect on P and Q Aim: To increase consumption of Merit Goods/prevent consumers being exploited E.g. Rent controls in NYC, milk price caps in Cyprus Quantity PFM QFM D PMax QD Price QS Max Price (price ceiling) Free Market Equilibrium S Diagram: In a free market, QFM of a good is traded at price PFM The max price ensures a lower price is charged, Pmax, and a higher Quantity is demanded, QD This improves the consumer surplus (for those who still consumes the good) However: at PMax there is excess demand! QD > QS QS is below QFM, so whilst consumers now pay less, fewer are now able to buy as there is a shortage in production
- 4. Minimum Prices Maximum & Minimum Prices Mr O’Grady
- 5. Minimum Prices Minimum Prices: A price floor for a market set by the government The cap must be below the free market equilibrium price to have any effect on P and Q Aim: To discourage consumption of Demerit Goods/prevent producers from being exploited E.g. Minimum alcohol prices in Scotland, minimum wages, EU Common Agricultural Policy Quantity PFM QFM D PMin QS Price QD Min Price (price ceiling) Free Market Equilibrium S Diagram: In a free market, QFM of a good is traded at price PFM The min price ensures a higher price is guaranteed to producers, Pmin, and a higher quantity is supplied, QS This improves the producer surplus (for those who still sell the good) However: at PMin there is excess supply! QS > QD Indeed, QD is below QFM, so whilst producers now get paid more, fewer are now able to sell as there is a surplus in production
- 6. Pros & Cons of Maximum & Minimum Prices Maximum & Minimum Prices Mr O’Grady
- 7. Pros & Cons of Maximum & Minimum Prices Pros of Max/Min Prices: Correcting Market Failure: Pushes consumption towards the socially optimal level Min. prices can be used to correct negative externalities However: max prices are not very successful at correcting positive externalities as QS falls below QFM Equity justification: Min prices ensure producers/workers are paid a fair price, max prices ensure consumers aren’t ripped off Whilst allocative efficiency may fall, there will be gains for one party who could previously have been exploited Competition: Max prices are a useful surrogate for competition Holds prices down, consumer welfare gains and incentivises businesses to cut costs in order to maintain profits Cons of Max/Min Prices: Reduces profits: Max prices cut profits, leaving less money for capital investment Market Distortion: Limits to signalling function May dissuade new entrants Ineffective: Firms with max prices might raise prices in other ways (e.g. management fees) Inflation: Higher labour costs (min wages) and prices will cause higher inflation, lowering real income Competitiveness: Min prices/wages will mean that domestic firms are less able to compete with overseas firms, harming the balance of trade Black Markets: If max. prices lead to excess demand, then there will be some consumers willing to pay more than the capped price, and an incentive for firms to enter black markets
- 8. Limitations of Maximum & Minimum Prices Maximum & Minimum Prices Mr O’Grady
- 9. Limitations of Maximum & Minimum Prices Price Quantity QFM D-Elastic PFM S Min Price QD QS Price Quantity QFM D-Inelastic PFM S Min Price QD QS Elastic PED Inelastic PED Elasticity: The extent to which quantity demanded falls from imposition of a minimum price/wage depends on the PED More inelastic PED, fewer producers are priced out by the min price. Gained PS is more evenly distributed Similar Analysis can be used for PES and Max prices Magnitude: The extent to which consumers/producers gain will depend on how far the max/min price differs from the free market price Max prices need to be below PFM and Min prices need to be above PFM to have any affect Subjective: Setting max/min prices involves a normative judgement The state of the economy: Firms must be sufficiently profitable to be able to absorb a higher minimum wage/lower market prices Otherwise, there will be cuts to economic growth and increased unemployment
- 10. Alternatives to Maximum & Minimum Prices Maximum & Minimum Prices Mr O’Grady
- 11. Alternatives to Maximum & Minimum Prices Alternatives to Max Prices: Measures to reduce barriers to entry: For example, deregulation or interest-free loans These will lead to increased supply and a lower market price without the shortage Higher taxes on monopoly profits: For example, a windfall tax (100% tax on profits above a certain amount) This will ensure that firms have reduced incentive to raise prices and exploit consumers Alternatives to Min Prices: Indirect Taxes: For example, alcohol duties Corrects the negative externality, but also generates government revenue Alternatives to Min Wages: Income Tax Reforms: For example, cutting basic rate of income tax or increasing the tax-free allowance This will boost work incentives Measures to raise labour productivity: For example, increased education/training provision Most important in long run Higher productivity boosts wages / incomes
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