A form of government intervention in the economy in which a government agency uses its law-making power to regulate the prices at which otherwise voluntary private exchanges may take place. The government agency may attempt to fix and enforce the exact prices at which a particular good or service may be sold (as for example when state regulatory commissions fix the rates for electricity, gas or water to be sold by monopoly utility companies in particular geographic areas).
Price control refers to a direct measure on the part of the Government in fixing the prices for achieving certain macro economic goals like social welfare, efficient resource allocation, prevention of exploitation of the consumers etc.
The Price Control may be informal or formal. In case of informal price control the producers voluntarily agree to regulate the prices which are within limits suggested by the Government whereas under formal price control, the prices are statutorily fixed by the Government and have to be accepted by the producers.
The Price Control may be total or partial. In case of total price control the price of the entire stock of output is enforced and administered by the Government through a Public Distribution System. For example: In case of any particular drug produced by a private sector the price control is total. This is also referred to as mono-pricing of the commodity. In case of partial price control, the Government directly fixes the price of a part of the production of a commodity and arranges for its distribution may be through fair price shops or via the systems of rationing. The rest of the stock is allowed to be sold in open market at any price which is determined by the free play of market mechanism. Partial control therefore acquires the form of dual pricing.
Alternatively, the government agency may be content to set “ceiling prices” or “floor prices” for particular goods or services. Ceiling price controls set a maximum price that may be charged but do not prohibit transactions at lower prices below the ceiling price (for example, rent control). Floor price controls set a minimum price that may legally be charged but do not prohibit transactions at higher prices above the floor price (for example, minimum wage laws).
A price ceiling occurs when the government puts a legal limit on how high the price of a product can be. In order for a price ceiling to be effective, it must be set below the natural market equilibrium. It is also known as maximum price.
Maximum Price is where price can’t rise above a certain level. This can reduce prices below the market equilibrium price. The advantage is that it may lead to lower prices for consumers.
The disadvantage is that it will lead to lower supply. There will also be a shortage, demand will exceed supply; this leads to waiting lists and the emergence of black markets as people try to overcome the shortage of the good and pay well above market price.
Diagrammatic Representation of Maximum Price
For the price that the ceiling is set at, there is more demand (Q2) than there is at the equilibrium price. There is also less supply (Q1) than there is at the equilibrium price, thus there is more quantity demanded than quantity supplied i.e. shortage.
Impact of Price ceiling
Inefficiency: Inefficiency occurs since at the price ceiling quantity supplied the marginal benefit exceeds the marginal cost. This inefficiency is equal to the deadweight welfare loss.
Existence of black market: Due to demand exceeding the supply, there will be buyers who will be willing to purchase the good at a higher price. This will lead to existence of black market.
- During the second world war, price of goods was fixed and good rationed. However, this encouraged people to sell on the black market through inflated prices.
- Tickets for football prices and concerts are often set at a maximum price. (e.g. if left to the market, equilibrium prices would be much higher). e.g. at current prices F.A. Cup final could sell many more tickets than 80,000.
- The government may set a maximum price for renting to keep housing affordable.
A minimum allowable price set above the equilibrium price is a price floor. With a price floor, the government forbids a price below the minimum Price Floors are minimum prices set by the government for certain commodities and services that it believes are being sold in an unfair market with too low of a price and thus their producers deserve some assistance.
Minimum prices are used to give producers a higher income. They are used to increase the income of farmers producing goods.
For example, the EU had a Common Agricultural Policy (CAP). This increased the income of farmers by setting minimum prices.
Diagrammatic Representation of Minimum Price
Government might set Minimum prices
- To raise incomes for producers such a farmers and protect them from frequent fluctuations in the commodity market.
- To protect workers and ensure that they get a enough wages to sustain a reasonable standard of living.
Examples of price floors
- In many countries governments assist farmers by setting price floors in agricultural markets.
- Setting Minimum wages for certain occupations is also an example of price floors.
The Disadvantage of Minimum Prices
- Higher prices for consumers. We had to pay more for food
- Higher tariffs necessary on imports. The EU put tariffs on food to keep prices artificially high.
- May encourage oversupply and inefficient. The CAP encouraged farmers to produce food that no one actually wanted to eat.
- We had over-supply (butter mountains, wine lakes)
Price controls take many different shapes – minimum wage, rent control, any control on production, subsidies, tariffs, and taxes, amongst others. The problem with all of these is that they in effect distort the profit and loss system of an economy. Whenever a price control is created, it has horrendous effects.