Question

Explain why governments sometimes attempt to pass legislation to prevent “price gauging.” Draw a diagram that shows this scenario, and explain what may occur if such legislation is passed.

Answer 1

Price Gauging is said to have happened in any market, primarily when the sellers begin charging a price which is higher than the equilibrium price otherwise. This happens when there is excessive demand in the market which usually stems from a natural calamity in the economy or due to other reasons such as mass scale diseases in the recent times which have led to a rapid surge in the demand for hand sanitizers or face masks. The end result is that the overall prices become much higher and result in inflation in that particular market.

Most governments want their best to control price gauging as it reduces the interests of the consumers and results in unfair profits for private players at the cost of inflation in the economy. They do so by setting a maximum limit on the price which the producers are allowed to charge from consumers. This then forces the sellers to reduce the price of goods and services while earning reasonable profits and helps in controlling the inconsistent price rise in the economy. One of the famous price ceilings have been adopted by governments to control the market for face masks and sanitizers the demand for which has gone up during the pandemic substantially and has given suppliers an advantage to increase costs way higher than normal equilibrium conditions.

An example of a price ceiling graph is explained as follows: -

In the above graph we see that the initial price is higher and the government believes that there is a need to decrease the same. Therefore, it is reduced to the ceiling price at which there is a binding impact that above this price the producers cannot sell the product. At this price even though, the number of producers may get low, but there is a great impact on consumer surplus wherein the change in demand is higher than the change in supply as indicated by the arrow.

This then leads to the price gauging being ineffective as the suppliers are forced to sell the products at a price lower than they earlier were.