Lets take up a role of Policy Maker and analyse how government policy affect the market outcome.
Not all markets are allowed to function freely. Supply and Demand may result in prices that are unfair to buyers or to sellers. Government may set a price and it may differ from the equilibrium price that the market sets.
This action will interfere with the “clearing function” which equilibrium conditions create. A shortage (as in the case of a price that is below equilibrium) or a surplus (as in the case of a price that is above equilibrium) is the result of these government price setting actions.
- There are two types of price control: price ceilings and price floors. Price ceilings sets a legal maximum price at which a goods can be sold. A price floors sets a legal minimum price at which a good can be sold.
- Price Ceilings: In a competitive market, a price that is below the equilibrium causes shortages, because quantity demanded exceeds quantity supplied. The resulting shortage tends to put upward pressure on price until it goes back to equilibrium and eliminating the shortage. On the other hand, if the government sets a price ceiling that is above or higher than the equilibrium price, it will have no effect.
Suppose the market for Vaccines is in ……..)
The Government believes that the equilibrium price is TOO HIGH in this market. So as Policy Makers they enact a Price Control to keep Prices Low to Benefit the Consumers.
A Price Ceiling is the Maximum Legal Price that firms can charge for a product in a market or industry. The main objective is to make the product more affordable by keeping the market from reaching equilibrium price. This results in Shortage as Quantity Demanded is greater than Quantity Supplied.
If Price Ceiling is ABOVE the equilibrium then it would be INEFFECTIVE because it defeats the objective of this price control. The result will vaccines will be JUST AS EXPENSIVE. Firms will simply charge at the established equilibrium prices!!
- Price Floors: If a government imposes minimum price above the equilibrium price it will cause a surplus as it results in quantity supply exceeds the quantity demanded. This resulting surplus will put a downward pressure on price until it eliminates surplus by going back to the equilibrium. If a price floor is blow the equilibrium it will have no effect.
Suppose the market for Corn is in …….?
The government believes that the equilibrium price is TOO LOW in the market. So adopting a role as Policy Maker they enact a price control to keep Prices High to Benefit the Producers.
A Price Floor is the Minimum Legal Price that consumers can ask for a product in a market or industry. The objective is to make this product more expensive by keeping the market from falling to equilibrium price. This results in Surplus, as Quantity Supplied is greater than Quantity Demanded.
If the Price Floor is Below the equilibrium it would be Ineffective because it defeats the objective of this price control. The farmers will make Inadequate Revenue. Corn will simply sell at the established equilibrium price!!
- Economic behaviour does not change when price floors and ceilings are set. People will continue to make their best choices as they respond to the changes that alter the costs and benefits of the decision. Since people make decisions usually unpredictable ways, we can predict consequences of the price-setting laws.