Maximum Price (Price Ceiling)- Full Market Impact Flashcards
(23 cards)
Maximum Price (Price Ceiling) - Definition
A type of price control enacted by the government.
* A fixed price set below the equilibrium market price.
* Legally prevents prices from rising above this level.
Why set a Maximum Price Below Equilibrium?
Because the government believes the equilibrium market price is too high, making essential goods or services unaffordable for many consumers.
Primary Purpose of a Maximum Price
To increase affordability and access to essential goods or services for consumers, especially low-income households, by lowering the price.
Examples of Goods/Services where Maximum Prices might be used
Rent/housing accommodation (rent control), basic food staples, essential medicines, or utilities (though these are often regulated differently).
Noble Intention” of Maximum Prices (as you put it!)
To ensure that essential goods and services are accessible and affordable to a wider population, addressing concerns about equity and living standards.
Maximum Price (Pmax) on a Supply/Demand Diagram
A horizontal line drawn below the initial equilibrium price (P1).
* Represents the legal ceiling above which the price cannot rise.
Impact of Pmax < P1 on Quantity Demanded
Causes an expansion in demand. As the price decreases from P1 to Pmax, the quantity demanded rises from Q1 to QD (movement along the demand curve).
Impact of Pmax < P1 on Quantity Supplied
Causes a contraction in supply. As the price decreases from P1 to Pmax, the quantity supplied falls from Q1 to QS (movement along the supply curve).
Result of Pmax < P1 on the Market
Creates a situation where Quantity Demanded (QD) > Quantity Supplied (QS). This results in an excess demand or shortage equal to the difference between QD and QS.
The Quantity Actually Traded in the Market with a Maximum Price
The quantity traded will be limited by the lower of the two quantities, which is the quantity supplied (QS). Producers will only supply QS at Pmax, and that’s all that can be bought.
Problem of Excess Demand (Shortage) from Pmax
There are more consumers willing and able to buy the good at Pmax than there is supply available. This leads to queues, waiting lists, rationing, or potentially the development of black markets.
The Quantity Actually Traded (Reinforced) and its Implication
The quantity traded is limited to the quantity supplied (QS) at Pmax. This means many consumers who are willing and able to buy at Pmax (the excess demand) are unable to access the good, not due to price but due to lack of supply.
Producer Revenue with a Maximum Price
Producers sell the limited quantity supplied (QS) at the maximum price (Pmax). Revenue = Pmax * QS. This is likely lower than the initial equilibrium revenue (P1 * Q1) because both price and quantity supplied have decreased. (You described this as Area PmaxQS O).
Impact on Producer Surplus with a Maximum Price
Producer surplus is significantly reduced because both the price received and the quantity sold are lower. Producers may be discouraged from operating in this market.
Deadweight Welfare Loss (from Maximum Price) - Concept
A loss of economic efficiency because the quantity traded (QS) is less than the initial equilibrium quantity (Q1). This represents the loss of potential gains from trade between consumers and producers who would have traded at prices between Pmax and P1 for quantities between QS and Q1.
Deadweight Welfare Loss (from Maximum Price) - Location on Diagram
The triangular area between the demand and supply curves, for the quantities between the new quantity traded (QS) and the initial equilibrium quantity (Q1). (You labelled this as Area DBL or similar on your diagram).
Impact of Maximum Price on Consumers (Detailed)
*Positive (for some):** Those who can access the good benefit from lower prices (Pmax) and potentially increased consumer surplus (for the quantity they buy).
* Negative (for many): Many consumers (the excess demand) cannot access the good at all due to the shortage.
* Negative: May face non-price rationing (queues, waiting lists).
* Negative: May be forced to seek supply in potentially illegal, unregulated, or dangerous black markets.
Impact of Maximum Price on Producers (Detailed)
Negative:** Significant reduction in revenue (Pmax * QS).
* Negative: Reduction in producer surplus.
* Negative: Discouraged from supplying the market, potentially leading to producers leaving the industry (contraction of supply in the long run).
* Negative: Less incentive to invest or improve quality.
Government Perspective on Maximum Prices
Positive (if goal achieved):** May achieve the objective of making essential goods more affordable for some consumers.
* Concerns/Negative:
* Failure to meet total demand (shortage).
* Negative impact on producers (reduced supply, leaving the market).
* Risk of unintended consequences (black markets, queues, reduced quality).
* Creation of a deadweight welfare loss.
* May require further intervention to address the shortage (e.g., subsidies, direct provision).
Problems Arising from Excess Demand (Shortage) caused by Maximum Price
Many consumers who want to buy cannot (lack of access).
* Leads to non-price rationing (queues, waiting lists).
* Potential for the emergence of illegal black markets where goods are sold above the legal maximum price.
Government Options to Address the Shortage from a Maximum Price
Subsidies:** Provide subsidies to private firms to reduce production costs and encourage them to increase supply (shifting the supply curve to the right).
* Direct Provision: The government could become a producer itself to increase the total supply available in the market.
Consequence of Government Intervention to Address the Shortage (e.g., Subsidies)
Cost to the Government:** Subsidies or direct provision are expensive, requiring funding through taxes or borrowing.
* Opportunity Cost: The money spent on addressing the shortage cannot be used for other beneficial areas of government spending.
* Highlights that the government intervention (setting the max price) created the problem (shortage) that now requires further intervention.
Overall Evaluation Point for Maximum Prices
While intended to increase affordability for some, maximum prices create shortages, reduce supply, lead to deadweight loss, and may require costly further government intervention, potentially leading to government failure.
