Government Intervention: Price Controls (AQA A Level Economics)

• Price controls are a type of government intervention in markets to change the existing market price
• To correct market failure, price controls are used to influence the levels of production or consumption in markets that are failing to allocate resources efficiently
• Two types of control are commonly used: maximum price (price ceiling) and minimum price (price floor)

• A price ceiling is a maximum price set by the government. Sellers cannot legally sell the good or service at a higher price
• The price ceiling is set below the existing equilibrium market price  
• Governments will often use price ceilings in order to help consumers if the market price is too high, especially for essential goods and services
• Sometimes they are used for long periods of time e.g. rent controls to keep rents lower in housing rental markets
• Other times, they are short-term solutions aimed at limiting unusual price increases e.g. petrol

Diagram: Impact of Price Ceiling

The price ceiling (P_max) sits below the free market price (P_e) and creates a condition of excess demand (shortage)

Diagram analysis

• The initial market equilibrium is at P_eQ_e
• A price ceiling is imposed at P_max below the equilibrium level
• The lower price reduces the incentive to supply and there is a contraction in quantity supplied (QS) from Q_e → Q_s
• The lower price increases the incentive to consume and there is an extension in quantity demanded (QD) from Q_e → Q_d
• This creates a condition of excess demand (shortage) equal to Q_sQ_d
   
• The aim of this policy is to promote equity in the market for essential goods and services and it attempts to solve market failure caused by income inequality

Evaluating the use of Price Ceilings (Maximum Prices)

Advantages

Disadvantages

Some consumers benefit as they purchase at lower prices. For these consumers, their consumer surplus increases Price ceilings can stabilise markets in the short-term during periods of intense disruption, e.g. Covid supplies at the start of the pandemic

Some consumers are unable to purchase due to the shortage Producers lose out as the price is below what they would usually receive: their producer surplus falls The unmet demand usually encourages the creation of illegal markets and exploitation of consumers Maximum prices distort market forces and therefore can result in an inefficient allocation of scarce resources e.g. price ceilings of housing rentals in the property market create a shortage When used in necessity markets, Governments may be forced to intervene further by supplying the good/service themselves in order to meet the excess demand

• A price floor (minimum price) is set by the government above the existing free market equilibrium price and sellers cannot legally sell the good/service at a lower price
• Governments will often use price floors to help producers or to decrease consumption of a demerit good
  • In Wales and Scotland, governments have introduced a minimum price of alcohol at 50 pence per unit
    
    
• Minimum prices are also used in the labour market to protect workers from wage exploitation. These are called minimum wages

Diagram: Impact of a Price Floor

Price floor (Pmin) is set above the free market price (Pe) creating a condition of excess supply (surplus)

Diagram analysis 

• The initial market equilibrium is at P_eQ_e
• A price floor is imposed at Pmin above the equilibrium level
  • The higher price increases the incentive to supply and there is an extension in supply from Q_e → Q_s
  • The higher price decreases the incentive to consume and there is a contraction in demand from Q_e → Q_d
  • This creates an excess supply equal to Q_dQ_s 
    
    
• In the case of demerit goods, this discourages consumption, reducing output to a level closer to the socially optimal level of output

Evaluating the use of Price Floors (Minimum Prices)

Advantages

Disadvantages

In agricultural markets, producers benefit as they receive a higher price (Governments will often purchase the excess supply and store it or export it) Producers are protected from price volatility When used in demerit markets, output falls (Governments will not purchase the excess supply of a demerit good) Producers usually lower their output in the market to match the QD at the minimum price and this helps to reduce the external costs

It costs the government to purchase the excess supply and an opportunity cost is involved Some producers such as farmers may become over-dependent on the Government's help Producers lower output which may result in an increase in unemployment in the industry If demand is price inelastic, the increase in price does not impact QD or solve the market failure