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Price Controls-Maximum Price

Terms/Ideas:

Advantages of a maximum price | Black market & a maximum price | Calculations & a maximum price | Ceiling Price | Maximum Price Control | Reasons for a maximum price

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Maximum price control (ceiling price)

A price control (maximum or minimum price) is imposed by government so that price cannot automatically move back to the equilibrium as it would in the free market because laws or regulations prohibit this.

A maximum price (or ceiling price) is a price control set by government prohibiting the charging of a price higher than a certain level. A maximum price is set in the interests of consumers to protect them from paying unreasonably high prices for essential goods and services, for example housing, petrol or certain food items such as bread and milk.

The advantages of a maximum price control is that it will lower the price of the good or service and make it more affordable for consumers, and there is no cost to the government. The problem of an effective maximum price set below the equilibrium is that it distorts the market because it does not allow the market to clear. A maximum price set below the equilibrium results in a shortage (excess demand), because at prices below the equilibrium the quantity demanded by consumers is greater than the quantity supplied by producers. This means that some consumers who had the good or service before the maximum price was imposed miss out because the quantity supplied decreases as the price falls. Solutions to overcome the shortage created by a maximum price could be first-come-first-served until supply runs out, or the government could issue ration cards giving an equal share to everyone.

A black market can arise with a maximum price. A black market is part of the underground or informal economy where activities that take place are illegal, unregulated and not taxed. In a black market, firms charge a price above the legally set government maximum price or well-off customers or consumers pay more than the government’s legally set price or obtain the good or service that circumvents rationing measures put in place by the government.

If the government sets a maximum price control of $350 for the market of houses to rent this restricts the rent that landlords are legally allowed to charge tenants.

The diagram shows that imposing a maximum price at $350 for a house to rent will cause the price to fall from $450 to $350. As the price decreases the quantity demanded of houses by consumers (potential tenants) increases from 3 500 (Q) to 4 000 (Qd), while the quantity supplied of houses made available to rent by landlords decreases from 3 500 (Q) to 2 500 (Qs). This causes a shortage of 1 500 houses to rent and could give rise to a black market where some people are willing to pay a higher price than the legally set price by government of $350 to rent a house.

The change in total value of sales after the maximum price is imposed is the difference between the original price multiplied by the original quantity (P multiplied by Q) and the maximum price set multiplied by the quantity made available by suppliers (Maximum Price multiplied by Qs). In this instance, it is the difference between ($450 multiplied by 3 500) and ($350 multiplied by 2 500) which is the difference between $1 575 000 and $875 000, a $700 000 decrease.

A maximum price set above the equilibrium price has no effect because a price above the equilibrium price creates a surplus (excess supply) where market forces automatically cause the price to decrease back to the equilibrium. Therefore, to be effective, a maximum price must be set below the equilibrium.

To assist individuals and families moving into affordable housing the government could increase the supply of houses to rent by offering landlords a subsidy. A subsidy is a payment by government to suppliers (businesses) to keep costs down, as a result they will increase supply and the price will decrease. The advantage of a subsidy over a maximum price control is that there will be no shortage and the market will clear. The disadvantage of a subsidy is that it may be very expensive for the government, and the money spent on the subsidised good or services means this money cannot be spent elsewhere.

 

 

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