Price Ceiling and Price floor

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

Government Policies That Alter the Private Market Outcome

Price Controls measures :

Price Ceiling: a legal maximum on the price of a good or service. Example: rent control.

Price Floor: a legal minimum on the price of a good or service. Example: minimum wage.

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

EXAMPLE 1: The Market for Apartments

Equilibrium without price controlsEquilibrium without price controls

P

QD

SRental price of apartments

$800

300Quantity of apartments

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

How Price Ceilings Affect Market Outcomes

• Price ceiling above the equilibrium price is not binding –has no effect on the market outcome.

P

QD

S

$800

300

Price Ceiling

$1000

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

How Price Ceilings Affect Market Outcomes

• The equilibrium price ($800) is above the ceiling and therefore illegal. The ceiling is a binding constraint on the price, causes a shortage.

P

QD

S

$800

Price Ceiling

$500

250 400

Shortage

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

How Price Ceilings Affect Market Outcomes

• In the long run, supply and demand are more price-elastic. Therefore, the shortage will be larger.

P

QD

S

$800

150

Price Ceiling

$500

450

Shortage

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

EXAMPLE 2: The Market for Unskilled Labor – Equilibrium without price controls

W

LD

SWage paid to unskilled workers

$4

500

Quantity of unskilled workers

Equilibrium Price

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

How Price Floors Affect Market Outcomes

• A price floor below the equilibrium price is not binding – has no effect on the market outcome.

W

LD

S

$4

500

Price floor

$3

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

How Price Floors Affect Market Outcomes

• The equilibrium wage ($4) is below the floor and therefore illegal. The floor is a binding constraint on the wage, causes a surplus(i.e., unemployment).

W

LD

S

$4

Price Floor

$5

400 550

Labor Surplus

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

The Minimum Wage

• Minimum wage laws do not affect highly skilled workers.

Often, they affect teen workers.

W

LD

S

$4

Minimum Wage$5

400 550

Unemployment

Are price controls an effective mechanism to influence the prices in a free market?

Laissez Faire/Free Market Economics Associated with capitalism Role of Government Equilibrium Level

Price Controls Role of government Reasons for implementation Changes the Equilibrium Level

Price Floor

What is Price Floor?Minimum prices set by government for a particular good or labor.

ProsHigher Income for ProducersHigher Income for Labor

ConsHigher Prices for consumersEncourage oversupply and IneffeciencyHigher Unemployment

Price CeilingWhat is Price ceiling ?Maximum prices set by government for a particular good/service.

ProsAffordabilityAddresses to a wider section of the society

Cons Lowers the SupplyCreates shortageEmergence of Black Markets

Ineffectiveness of Price Ceiling • Price ceiling ineffectiveness on a Global level - During the peak or ceilings prices of a product, a part of market does not abide to it. For ex, Year 2006, Venezuela’s price ceilings on coffee reached a breaking point as the same resulted in farmers hoarding the beans and been sold at loss at government prices. Further, the same led to formation of black market in the capital city and shortage.

• India – Pharmaceuticals companies product “Atorvastatin” for prevention of ailment diseases, are sold from INR 9 per strip of 10 tabs to INR 90 per strip of 10 (the price leader), even as the price of the public procurement agency, Tamil Nadu Medical Services Corporation Ltd (TNMSC), is INR 2.13 per 10 tabs. The ceiling price would, therefore, be around INR 70-80 per 10 tablets and that is still a high price when the bare cost for procurements is around INR 2 per 10 tablets.

Ineffectiveness of Price Ceiling

• Indonesia – Airlines companies charged excess fares during the festival season violating all norms by transportation ministry. Further led the government to impose ceiling prices on all modes of transportation to prevent soaring prices.

Examples for Price Floor

• US Minimum wage laws – Fixed salary or remuneration employers are required to pay to employees.

• Price floors are often used in Agriculture sector in order

to protect the farmers.

Summary :

Price Floor is the regulated lowest price set to benefit the poor.

Economy and its development - However, price control often interfere with functioning of free economy and also the markets and many times becomes hurdle to growth of the economy.

Production houses, middleman all are held responsible. However government uses these economic tools with backdrop of political motive and welfare of part section of the society.

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