Question

Explain what price control is. Provide some examples. Why do we observe pernicious effects as a result of price controls? Did you observe recent price controls, especially during COVID? Provide some explanation of the unintended consequences of those recent price controls. We also mentioned that some companies prefer not to establish price controls but to limit the number of goods people buy? How do you explain that behavior if we know those are profit-seeking organizations?  

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Thanks beforehand for any help!

Answer 1

Price control: When Government has to intervene in the process of price determination when the equilibrium price so determined is either too high for the consumers or too low ( i.e. unprofitable) for the producers of the commodity.

Example

i) Price Ceiling : It refers to fixing the maximum price of a commodity at a lower than the equilibrium price.

In the diagram 1 , demand curve DD and supply curve SS of wheat intersect each other at point E and as a result equilibrium price OP is determined.

- Suppose the equilibrium price of OP is very high and many poor people are unable to afford wheat at this price.

- As wheat is an essential commodity, government interfere and fixes the maximum price( known as price ceiling ) at OP1 which is less than the equilibrium price OP.

- At this controlled price the quantity demanded ( OQ_D) exceeds the quantity supplied ( OQ_S) by Q_s Q_D.

​​​​​- It creates a shortage of MN and some consuners of wheat go unsatisfied.

But price ceiling has certain drawbacks :

i) Black markets : A black market is any market in which the commodities are sold at a price higher than the maximum price fixed by the government.

ii) Difficulty in obtaining goods from ration shops : Consumers have to stand in long queue to buy goods from ration shops.Sometimes, commodities are not available in the ration shops or goods are of inferior quality.

PRICE FLOOR - It refers to the minimum price ( above the equilibrium price ) , fixed by government, which the producers must be paid for their produce.

- When Government feels that the price fixed by the forces of demand and supply is not remunerative from the producers' point of view, then it fixes a price ( known as Price Floor) which is more than the equilibrium price. like in agricultural price support programmes and minimum wage legislation.

As seen in the diagram 2, equilibrium is determined at E when demand curve DD and supply curve SS of wheat intersect each other.The equilibrium price of OP is determined.

- Suppose, to protect the producers' intersect and to provide incentive for further production, government price of OP.

- At this support price (OP2 ) , the quantity supplied ( OQS) exceeds the quantity demanded (OQD) by QSQD.

- This creates a situation of surplus in the market which is equivalent to MN in the diagram.The excess supply may be purchased by the government either to increases its buffer stocks or for exports.