Question

1. List some of the problems that may arise when prices are controlled

2. A market system works very well in solving some basic problems of the economy but it fails in some cases. Provide examples.

Answer 1

Answer 1

Price controls are government-mandated legal minimum or maximum prices set for specified goods. They are usually implemented as a means of direct economic intervention to manage the affordability of certain goods.

Problems created by Price Controls

Shortage

Shortage, in economic terms, is a condition where the quantity demanded is greater than the quantity supplied at the market price.In a normally functioning market, there is an equilibrium between the quantity demanded and quantity supplied at a price point dictated by market forces. A shortage is a situation in which demand for a product or service exceeds the available supply. When this occurs, the market is said to be in a state of disequilibrium

Rationing

Rationing is the practice of controlling the distribution of a good or service in order to cope with scarcity. Rationing is a mandate of the government, at the local or federal level. It can be undertaken in response to adverse weather conditions, trade or import/export restrictions, or in more extreme cases, during a recession or a war.

Black Market

A black market is economic activity that takes place outside government-sanctioned channels. Black market transactions usually occur “under the table” to let participants avoid government price controls or taxes.

Low Product Quality

Due to government intervention suppliers are forced to supply the product at low price. This results in reduction in product quality by the producers.

Answer 2

Market System

A free market economy can be defined as a economy where market equilibrium is determined by free forces of supply and demand and there is little or no government intervention.

Benefits of Market System

• It contributes to political and civil freedom, in theory, since everybody has the right to choose what to produce or consumer.
• It contributes to economic growth and transparency.
• It ensures competitive markets.
• Consumers' voices are heard in that their decisions determine what products or services are in demand.
• Supply and demand create competition, which helps ensure that the best goods or services are provided to consumers at a lower price.

Examples of Success

For example, the deregulation of AT&T, which previously functioned as a regulated national monopoly, in the 1980s provided consumers with more competitive long-distance telephone rates.

Also, the deregulation of U.S. airlines in 1979 provided consumers with more choice and lower air fares.

The deregulation of trucking companies and railroads also increased competition.

Market Failure

Market failure occurs whenever the individuals in a group end up worse off than if they had not acted in perfectly rational self-interest. Such a group either incurs too many costs or receives too few benefits. The economic outcomes under market failure deviate from what economists usually consider optimal and are usually not economically efficient.

Types of Market Failure

Public Goods

Public goods create market failures if some consumers decide not to pay but use the good anyway. National defense is one such public good because each citizen receives similar benefits regardless of how much they pay.Use of Public Parks is another example.

Externalities

An externality is an economic term referring to a cost or benefit incurred or received by a third party. However, the third party has no control over the creation of that cost or benefit.Pollution emitted by a factory will affect the health of nearby residents.

Monopoly

A monopoly is created when a company and its product offerings dominate the society.A monopoly lacks both productive and allocative efficiency. It may charge high prices from customers.

Examples of Market Failure

Market failures can occur in government activity also.Rent-seeking by special interest groups. Special interest groups can gain a large benefit by lobbying for small costs on everyone else, such as through a tariff. When each small group imposes its costs, the whole group is worse off than if no lobbying had taken place.

Deregulation of Cable TV has resulted in increasing the prices for consumers.

Another example of free market failure can be seen in environmental issues.

Oil industry is spilling oil in the sea and thus creating water pollution and affecting the health of people and sea creatures.The single-hulled oil tanker Exxon Valdez spilled 11 million gallons into Prince William Sound in 1989 but no serious action was taken.

Pollution of many essential and important water bodies is affecting health of people.Example the Cuyahoga River in Northeast Ohio. The pollution of the Indian river Holy Ganga has reached to such a extent that government had to take concrete steps to clean it.

To conclude, we can say that critics of a free market system argue that although some aspects of the market may be self-regulating, other things, such as environmental issues are the biggest disadvantage of market system and this calls for the need of government intervention.