PRICE CONTROL–(PRICE CEILING AND PRICE FLOOR)

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Often, the government observed that the price charged for goods are too high for consumers or low for producers. 

Consequently, they use their power to regulate prices–a process called price control.
 
Price control is a process by which the government through its agencies enact laws to regulate prices.

Price control comes in two flavours: price ceilings and price floors.

Price ceiling
This is a government-mandated maximum price under which legal trade can be made. A price ceiling is the highest legal price that can be charged for goods and services.

For instance, if the government mandates that the maximum price at which rice can be bought is €40. It follows that €40 is the price ceiling.

As the name suggests, the price ceiling prevents the price from rising above a certain level (the ceiling).

It is important to note that a price ceiling will only be valid if it is fixed below the equilibrium price, otherwise, it would not affect the market. 

Price ceilings ensure that consumers are protected from exploitation by producers who may want to charge high prices.

A good example of a price ceiling is rent control. Rent control maximized the amount by which rent can be increased, thereby minimizing to the barest minimum the possibility of tenant displacement.

EFFECT OF PRICE CEILING

1. Shortage: If you have read my post on equilibrium, you would be cognizant of the fact that shortage occurs when the price is fixed below the equilibrium–a situation common with the price ceiling.

As you saw on the graph above, the price ceiling ensures that there is a shortage as quantity demanded would exceed quantity supplied.

When this shortage exists, there is a tendency for price and quantity to adjust to the equilibrium. 

But when there is a price ceiling, this tendency is unrealizable, at least legally, as it is unlawful to trade at the equilibrium price.

2. Inefficiency: When goods and services are sold at the equilibrium point, there is efficiency due to the absence of deadweight loss.

An effective price ceiling means goods and services would be sold below the equilibrium price. 

This means there will be inefficiency as there will be a loss in economic surplus (sum of consumer surplus and producer surplus).

When there is a price ceiling, the price of goods will be lower, thereby causing a reduction in producer surplus. 

The price ceiling will also cause a reduction in consumer surplus as gain from the price increase will be outweighed by loss from a reduction in quantity supplied (caused by low prices). 

This would lead to deadweight loss or a net decrease in total economic surplus.

3. Non-price rationing devices: Another consequence of a price ceiling is that goods may be rationed using non-price devices.

Shortage, as you know, means demand exceeds supply. 

Naturally, when there is a shortage, there is a tendency for the price of goods to increase so that goods would be rationed based on price.

But with a price ceiling, this tendency is not realizable. Therefore, other rationing devices like first-come, the first-serve basis would be used to rationed sales.

To illustrate, if ten quantities of pens(sold at €3) are demanded but only four are available for supply. 

The pen would not be rationed using only price, it could be rationed using a first-come, first-serve basis.

This means to buy a pen, you would not only pay €3, but you would also need to be among the first four people to buy the pen.

4. Emergence of the black market: When goods are rationed using non-price devices, few people are left dissatisfied because there are not enough goods to buy.

So, what do these people do?

They turn to an informal but illegal market called the black market.

In the black market, consumers can buy as much good as they want, provided they pay a price higher than the price ceiling. 

Though black markets are generally illegal, they provide higher profits for producers and more of a good for consumers. 

This explains why many consumers and producers are willing to trade in black markets despite the threat of fines and imprisonment.

5. Encourages conditional sales: When there are shortages in supply, goods may be sold with conditions. 

For example, the seller may encourage tie-in sales–where consumers are requested to buy another product along with the goods in short supply.

As another example, the Landlord may request that the renter buy furniture, in addition, to rent payment before he is given the house when rent control is in place.

Price floor
This is a government-mandated minimum price above which legal trade can be made. A price floor is the lowest legal price that can be charged for goods and services.

For instance, if the government mandates that the minimum price at which rice can be bought is €70. It follows that €80 is the price floor.

The price floor prevents the price from falling below a certain level of (the floor). The price floor will only be effective if it is fixed above the equilibrium. 
The main aim of the price floor is to protect producers of certain goods and services from low prices.

The best-known example of a price floor is the federal minimum wage. As you know, employers are the consumer, while employees are the supplier.

Minimum wage ensures that employees are protected against low prices (in this case, the wages) so that they can provide for their basic needs.

EFFECT OF PRICE FLOOR

1. Surplus: For a price floor to be effective, it must be fixed above the equilibrium price. 

This means there would be a surplus (exceed supply) in the market as the quantity supplied will be greater than the quantity demanded.

When this surplus exists there is a tendency for price and quantity to adjust to the equilibrium. 

But when there is a price floor, this tendency is unrealizable, at least legally, as it is unlawful to trade at the equilibrium price.

2. Inefficiency: An effective price ceiling means goods and services are sold below the equilibrium as they would be a deadweight loss.

When there is a price floor, the price of goods will be high. 

Producer surplus, however, would decrease producer surplus as gains from the price increase will be outweighed by a decrease in quantity demanded(law of demand).

The price floor would also lead to a reduction in consumer surplus (caused by high prices). Hence, there would be a deadweight loss.

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3. Perishable goods may get spoilt: price ceiling is not a good policy for perishable goods.

Perishable goods are goods that are likely to perish if they are kept for a long period.

Price ceiling usually leads to surplus. This means perishable goods may get spoilt if there is no adequate storage.

4. Causes employment: in the labour market, employers are the consumers while employees are the supplier.

An effective price ceiling will lead to excess supply. Hence, they would be unemployed as they would be an excess supply of labour.


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