Application of Demand and Supply - Price Controls

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Price Floor

• Minimum price (lower price limit) allowed by legislation
• Government believes equilibrium price is too low
• Prices of all affected goods or services transacted cannot be below the minimum price allowed
• For a price floor to be effective, the legislated price, $P_{min}$, must be above the market equilibrium price
• Surplus occurs, as $Q_{supplied}>Q_{demanded}$
• Quantity transacted will fall
• Consumer surplus will fall
• With government intervention, producers can earn more
• A minimum wage may help reduce the income gap between higher and lower wage earners

Price Ceiling

• Opposite of a price floor
• Maximum price (upper price limit) allowed by legislation
• Prices of all affected goods or services transacted cannot be above the maximum price allowed
• For a price ceiling to be effective, the legislated price $P_{max}$ must be below the equilibrium price
• Shortage occurs, as $Q_{demanded}>Q_{supplied}$
• What alternative means of resource allocation can replace the price mechanism, now that a price ceiling is imposed?
  1. First come, first serve
  2. Rationing
  3. Government
• A black market may come into existence
• Underallocation of resources
  • producers don’t want to produce much at a lower price
  • therefore deadweight loss

Black Markets

• Any market where goods or services are sold illegally at prices above the legal price ceiling
• Exists because buyers are willing and able to pay higher than the legal price ceiling****** at the transacted quantity
• Profits can be made by those buying at the controlled price and selling at the black market price