3) Price controls - MB

Question 1

what is price control?

Answer 1

a legal maximum or minimum price

Question 2

what is price floor?

Answer 2

a legal minimum price

Question 3

what is price ceiling?

Answer 3

a legal maximum price

Question 4

what is are examples of price floor? (2 things)

Answer 4

• minimum wage
• alcohol minimum unit pricing

Question 5

what is an example of price ceiling?

Answer 5

rent control

Question 6

what does a maximum price do?

Answer 6

increases consumption, and therefore consumers’ utility, by making a good or service more affordable

Question 7

if a maximum price is set above the equilibrium price, what happens?

Answer 7

it will have no impact

Question 8

if the maximum price is set below the free market equilibrium price, what happens?

Answer 8

it leads to excess demand and a shortage

Question 9

what does a minimum price do?

Answer 9

• a minimum price increases production, the price producers receive, and therefore producer profits

Question 10

if a minimum price is set above the equilibrium price, what happens?

Answer 10

the free market equilibrium price it leads to excess supply and a surplus

Question 11

if the minimum price is set below the free market equilibrium price, what happens?

Answer 11

it will have no impact

Question 12

diagram:
where is the minimum price set?

Answer 12

set at P1 which is above the market clearing price of P0

Question 13

what does the minimum price (set at P1 above the market clearing price of P0) incentivise producers to do?

Answer 13

increase production, which leads to Q2 being produced

Question 14

Diagram for minimum price:
what does the increase in price mean?

Answer 14

means that fewer consumers can afford to buy the good or service, so only Q1 is consumed, this leads to a surplus of Q2-Q1

Question 15

Diagram for minimum price:
what is the government expenditure on the diagram?

Answer 15

(may or may not be the case, this is the case for crops but not alcohol)
- The government would be paying the maximum price to producers for all their produce not sold on the open market, leading to the government expenditure of P1 *(Q2-Q1)

Question 16

when may a minimum price be imposed on goods?

Answer 16

on a good that causes negative consumption externalities, which imposes an external cost on third parties which is not taken into account, and therefore is overconsumed

Question 17

how does minimum price improve allocative efficiency?

Answer 17

the minimum price reduces consumption towards MPC=MSC which improves allocative efficiency

eg alcohol minimum pricing in scotland

Question 18

diagram, maximum price:
where is P1?

Answer 18

a maximum price set at P1 is below the market clearing price of P0

Question 19

diagram, maximum price:
why does production fall to Q1?

Answer 19

the maximum price is set at P1 below the market clearing price of P0 which disincentives producers and production falls to Q1

Question 20

diagram, maximum price:
what does the reduced price mean?

Answer 20

that more consumers can afford to buy the good or service, so consumers demand Q2, this leads to a shortage of Q2-Q1

Question 21

how does the maximum price improve equality?

Answer 21

the maximum price allows lower income consumers to now demand the product, as they are now able to afford to buy the good or service. This improved access improves equality

Question 22

what are the advantages of maximum prices? (2 things)

Answer 22

1) cheap
2) reduces monopoly power

Question 23

how are maximum prices cheap?

Answer 23

it is quick and cheap for government to impose maximum prices as a method of improving equality

Question 24

how do maximum prices reduce monopoly power?

Answer 24

a maximum price limits a monopoly’s ability to profit maximise and exploit consumers

Question 25

what are the disadvantages of maximum prices? (3 things)

Answer 25

1) shortages reduces consumption 2) rationing may ensue 3) black markets

Question 26

how do maximum prices cause shortages that reduce consumption?

Answer 26

due to the shortage created some consumers, that are willing to pay more than the maximum price, are unable to buy it at all, lowering their potential utility

Question 27

how could maximum prices cause rationing?

Answer 27

to overcome the shortage, the government may need to allocate rations to consumers, which as a non- market based solution fails to efficiently allocate scarce resources

Question 28

how do maximum prices cause black markets?

Answer 28

the shortage may lead to a black market forming, and an opportunity cost of lost tax revenue

Question 29

what are the advantages of minimum prices? (2 things)

Answer 29

1) encourages investment 2) stockpiles

Question 30

how do minimum prices encourage investment?

Answer 30

the minimum income that producers receive incentivises them to invest

Question 31

minimum prices cause stockpiles, how is this advantageous?

Answer 31

stockpiles can mitigate the impact of severe weather

Question 32

what are disadvantages of minimum prices? (list 3 things)

Answer 32

1) lowers utility 2) high opportunity cost 3) allocative efficiency

Question 33

how do minimum prices lower utility?

Answer 33

consumers’ utility will be lower because, due to the higher price, they will be able to afford to buy and consume less

Question 34

how do minimum prices cause a high opportunity cost?

Answer 34

the opportunity cost of the government paying minimum prices is lower spending on other services such as healthcare or education

Question 35

how do minimum prices cause allocative inefficiency?

Answer 35

the surplus production is evidence of allocative inefficiency; the government then has to decide whether to stockpile, destroy or sell the surplus abroad

Question 36

why does a maximum price compare unfavourably to a subsidy?

Answer 36

maximum price fail to increase consumption as producers reduce production in response. It may therefore be necessary to subsidised production alongside a maximum price

Question 37

why does a minimum price compare unfavourably to a tax?

Answer 37

both act to reduce consumption and perhaps reduce negative externalities, but the tax raises revenue whereas the minimum price does not. It would improve allocative efficiency more to impose a tax alongside the minimum price and hypothecate the revenue to mitigate the impact of negative externalities