Government

Intervention:

Price Controls (Maximum & Minimum Prices)
GCE A-LEVEL & IB ECONOMICS

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Lesson Structure

◦Government Intervention
◦Maximum & Minimum Prices
◦Diagram, Examples and Evaluation
◦Taxes & Subsidies
◦Recap and Examples
◦Relation to Externalities / Market Failure
Horrific Prices!
Can each one of you think of something important to you, which you think is too
expensive or unfairly expensive?
Horrific Prices!
Consumers can be vulnerable, especially when
buying necessities that have an inelastic price
elasticity of demand (PED). This is because firms
tend to raise prices to maximize their revenues.
In this situation, the government may implement
Price Controls on goods/services to protect
consumer welfare and ensure we are not exploited.
A Price Control is when the government sets a
minimum or maximum price for a good or service.
Do you think the government should implement a
maximum or a minimum price to protect
consumers?
Purpose of Government Intervention

Governments intervene in order to reduce market failure to:

◦Ensure price fairness in the market
◦Reduce or eliminate negative externalities
◦Increase or maximise positive externalities
◦Increase the supply of merit goods
◦Reduce the supply of demerit goods
◦Supply public goods that would be undersupplied by the market
Maximum Price
Maximum Prices (or price ceilings) are generally imposed to protect consumers
or encourage consumption of merit goods. However, this tends to create excess
demand in the market due to the lower price.
This means there will be a greater quantity demanded of the good compared to
what is supplied, and not all consumers can benefit from buying the good at a
reduced price, as some will not be able to purchase it!
We can analyse this using a Demand & Supply diagram.
Maximum Price
Assume the price of renting a flat in London Price
S
is normally PE. Given the unreasonable
housing prices, the government now imposes
a maximum rent of PMax in the market.
Note that the maximum price will need to be P
E
below the original market equilibrium for it
to have an effect on the market. Otherwise P Max. Price
Max
producers will just sell at the original price of
PE. D

0 Q E Quantity
Maximum Price
Price
As the price is now lowered, the amount S
that suppliers are willing to produce will be
lower than the original equilibrium.

The maximum price will intersect the PE

supply curve and show a lower quantity
Max. Price
supplied by producers (Qs), which is lower PMax
than the previous market quantity (QE)
D

0 Qs Q E Quantity
Maximum Price
Price
On the other hand, the amount that S
consumers are willing to buy will increase
due to the fall in price.

The maximum price will intersect the PE

demand curve and show us the quantity
Max. Price
demanded by consumers (Qd), which is PMax
higher compared to the previous market
quantity (QE) D

0 Qs Q E Qd Quantity
 Maximum Price
As a result, there will actually be lower quantities Price
of the good available in the market. This is S
because even though there is high quantity
demanded (Qd), there is not enough quantity
supplied to meet the demand (Qd > Qs). We call
this situation in the market excess demand (or
PE
shortage), where the market lacks a quantity of
QsQd of the good. This means some consumers P Max. Price
Max
are unable to buy the good.
Excess Demand
(Shortage) D
The actual market quantity transacted will be Qs,
which is lower than the original equilibrium QE. Qd
0 Qs Q E Quantity
True or False?
- A maximum price needs to be implemented above the market equilibrium price to be
effective

- A shortage is when the quantity demanded in the market is higher than the quantity
supplied

- A price ceiling will increase the price of the good and decrease the quantity of the good
in the market

- Maximum prices are usually used so that producers can sell off their remaining goods
Pick who should answer next!
Challenge Yourself!
Split into groups of 2-3 and try to: Price
S

1. Draw a diagram illustrating a minimum

price imposed in a market

2. Discuss and explain how the minimum

price will affect the market price and
market quantity using your diagram

0 Quantity
Minimum Price
Price
S
When the government imposes a minimum
price (price floor), it has to be above the
market equilibrium to be effective. PMin
Min. Price

The situation is the exact opposite to when PE

a maximum price is implemented.

0 Q E Quantity
Minimum Price
Price
Due to higher prices, suppliers will supply S
more and consumers will demand less
quantities of the good.
PMin
Min. Price
The minimum price will intersect the
PE
demand curve to show that there will be a
quantity demanded of Qd in the market,
and a quantity supplied of Qs in the market.
D

0 Qd Q E Qs Quantity
Minimum Price
As a result, there will be excess supply Price
S
(surplus) in the market. There will be
quantities of QdQs of the good left unsold as Excess Supply
(Surplus)
consumers demand less from the minimum P
Min
price. Min. Price
PE
Overall quantity in the market will fall
compared to the previous market equilibrium
(Q E vs Qd), even though producers will
receive higher prices sold per unit. D

0 Qd Q E Qs Quantity
Why Minimum Prices?
Why Minimum Prices
- Price fairness to producers and suppliers, especially those with little bargaining
power (e.g. small businesses that sell to big retailers)

- To ensure production costs of the good is covered, sustainable and that it can
readily available in the market (e.g. availability of foodstuffs)

- To discourage consumption of certain goods that cause negative externalities

(e.g. Scotland’s consideration of min. price for alcohol.)
Evaluating Price Controls
Split into groups and research any
example of a maximum or minimum
price. (e.g. min wage, rent control)

Afterwards, each team should try to

suggest some limitations on the
effectiveness of price controls on
markets.
Limitations of Price Controls
Minimum price transfers consumer surplus to producer surplus; and maximum
price transfers producer surplus to consumer surplus. The government may get
set the wrong min/max price due to a lack of knowledge of the market, rendering
in ineffective.

Price controls will also reduce total welfare (total surplus) as a lower than
optimal amount of the good is transacted in the market.
Limitations of Price Controls
Price S Price
S

PE
PE
Max. Price
PMax

D D

0 QE Quantity 0 Qs Q E Qd Quantity
Limitations of Price Controls
A lower quantity in the market seems to be inevitable in theory. This means:
- A minimum wage will lead to higher unemployment levels as employers can
only afford to hire less workers
- A maximum price will cause lower quantities of the good available on the
market, even though the price is lowered and more people can afford it.

However, is this really the case in real life?

Limitations of Price Controls

How much quantity of the good falls in the market will depend on the elasticity
of demand for a minimum price, and the elasticity of supply for a maximum
price.

We can look into a minimum price as an example.

 Limitations of Price Controls
Price Price
S S
Excess Supply
(Surplus) Excess Supply
(Surplus)
PMin PMin
Min. Price Min. Price
PE PE

D (elastic)

D (inelastic)
0 Qd Q E Qs Quantity 0 Qd Q E Qs Quantity
Quick Questions
- What is the effect of a minimum price on the market?

- Explain a limitation of price controls.

- Draw out the diagram of a maximum price on the board.

Need help? Phone a friend!

 Min. Price Can Help with Negative Externalities!
Negative Production Externality Negative Production Externality
Price MSC MPC Price MSC MPC

MC MC

Min. Price
MB MB

MPB=MSB MPB=MSB

0 Q1 Q2 Output 0 Q1 Q2 Output
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