Question

Governments are frequently tempted to introduce price ceilings in markets. Use an example to explain why this is not such a good idea, at least when markets are competitive. Give some ideas as to what the government could do instead in order to help consumers in these markets.

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Answer 1

We know in competitive market prices of goods and services are determined by the forces of demand and supply. Interview in countries like India essentials of life like food grains and life-saving medicines are often found to be extremely scarce. Consequently their open market prices are often very high. This prices may be so high that the bulk of poor population find its difficult to buy them. It leads to undernourishment and malnutrition. Such a situation of fun compels the government to introduce price ceiling. It means fixing a maximum price for a commodity which is generally lower than the equilibrium market price.

Sealing means maximum limit. price ceiling means maximum price of a commodity that the seller can charge from the buyers. often the government fixes the price lower than the equilibrium price of a commodity so that the poor can afford to buy it.

However when price ceiling is introduced supply and demand forces are impacted. Let's assume that the concern community is bajra which is a staple food in the deserts of Rajasthan India. There is a large number of buyers and sellers of the commodity in the deserts. the market for Bajra is almost similar to that for perfect competition. Accordingly we are assuming that the market price of Bajra is determined by the forces of demand and supply.

MDb is the demand curve and MSb is the supply curve. E indicates the point of market equilibrium. OP is the equilibrium price and OQ is the equilibrium quantity. considering the fact that the poor people in the deserts of Rajasthan can not afford to buy Bajra at equilibrium price OP, the government fixes the price ceiling of OP* . It is lower than the equilibrium price. The story does not end here. ceiling price is likely to impact the market supply and market demand. When price reduces from OP to OP* , demand for Bajra extends from OQ to OQ2. on the other hand supply contracts from OQ to OQ2. A gap emerges between market demand and market supply. It is a situation of excess demand as D>S.

Excess demand = ab = Q1Q2

Excess demand for Bajra has its own implication.

It shows that people fail to buy Bajra to the extent they wished to buy. Accordingly a situation of partial hungered may continue to exist. How can this problem be tackled?

Rationing is the remedy. each person is allocated a fixed quota of Bajra at the ceiling price. accordingly everybody gets a fair amount of the commodity. the problem of hunger is addressed along with the problem of price.

But price ceiling with rationing is not totally free from demerits.

Following observations may be noted in this regard;

1. You are to stand in long queues to get your allotted quota of the commodity.

2. You may be offered a low quality product..

3. Ration goods are often sold in the black market rather than being delivered to the poor.

black marketing compounds the problem of scarcity and keeps poorest of the poor in a state of deprivation. if a price ceiling with rationing is to succeed the government must improve its distribution system. The government must evolve a system that insures that goods are actually deliver to the poor.

An alternative tool - direct benefit transfer ( DBT)

in the recent past government has evolved a system of direct benefit transfer briefly called DBT. According to the system rather than transferring benefit to the poor through some intermediary, the government is transforming cash benefit directly to the bank account of the beneficiaries. this has checked leakage of transfer and the beneficiaries are added without loss.

> Price ceiling -MS Price ceiling Price 'MDb Q1 Q Q2 Quantity Equilibrium Price = OP Equilibrium Quantitys og Keiling Price =P Excers demand = ab = Q192