2.7.3 Government Intervention: Price Controls, Direct Provision & Regulation

• Price controls are used by governments to influence the levels of production or consumption
• Two types of control are commonly used: maximum price (price ceiling) and minimum price (price floor)
   

Price Ceiling (Maximum Price)

• A price ceiling is set by the government below the existing free market equilibrium price and sellers cannot legally sell the good/service at a higher price
   
• Governments will often use price ceilings in order to help consumers
  • Sometimes they are used for long periods of time e.g. to keep rents lower in housing rental markets
  • Other times they are short-term solutions to unusual price increases e.g. petrol
     

The price ceiling (P_max) sits below the free market price (P_e) and creates a condition of excess demand (shortage)
   

Diagram Analysis

• The initial market equilibrium is at P_eQ_e
• A price ceiling is imposed at P_max
  • The lower price reduces the incentive to supply and there is a contraction in quantity supplied (QS) from Q_e → Q_s
  • The lower price increases the incentive to consume and there is an extension in quantity demanded (QD) from Q_e → Q_d
  • This creates a condition of excess demand equal to Q_sQ_d 
      

The Advantages and Disadvantages of Using Price Ceilings (Maximum Prices)

Advantages

Disadvantages

Some consumers benefit as they purchase at lower prices. For these consumers their consumer surplus increases Price ceilings can stabilise markets in the short-term during periods of intense disruption e.g. Covid supplies at the start of the pandemic

Some consumers are unable to purchase due to the shortage Producers lose out as the price is below what they would usually receive: their producer surplus falls The unmet demand usually encourages the creation of illegal markets (black/grey markets) as desperate buyers turn to illegal bidding Maximum prices distort market forces and therefore can result in an inefficient allocation of scarce resources e.g. price ceilings of housing rentals in the property market create a shortage When used in necessity markets, Governments may be forced to intervene further by supplying the good/service themselves in order to meet the excess demand

• A price floor (minimum price) is set by the government above the existing free market equilibrium price and sellers cannot legally sell the good/service at a lower price
   
• Governments will often use price floors in order to help producers or to decrease consumption of a demerit good e.g. alcohol
   
   

The imposition of a price floor (P_min) above the free market price (P_e) creates a condition of excess supply (surplus)

Diagram Analysis

• The initial market equilibrium is at P_eQ_e
• A price floor is imposed at P_min
  • The higher price increases the incentive to supply and there is an extension in QS from Q_e → Q_s
  • The higher price decreases the incentive to consume and there is a contraction in QD from Q_e → Q_d
  • This creates a condition of excess supply equal to Q_dQ_s 
         

The Advantages and Disadvantages of Using Price Floors (Minimum Prices) in Product Markets

Advantages	Disadvantages
In agricultural markets, producers benefit as they receive a higher price (Governments will often purchase the excess supply and store it or export it)   When used in demerit markets, output falls (Governments will not purchase the excess supply of a demerit good)   Producers usually lower their output in the market to match the QD at the minimum price and this helps to reduce the external costs	It costs the government to purchase the excess supply and an opportunity cost is involved Farmers may become over-dependent on the Government's help Producers lower output which may result in an increase in unemployment in the industry

  

• Minimum prices are also used in the labour market to protect workers from wage exploitation 
• A national minimum wage (NMW) is a legally imposed wage level that employers must pay their workers
  • It is set above the market rate
  • The minimum wage/hour usually varies based on age
     

A national minimum wage (NMW₁) is imposed above the market wage rate (W_e) at W₁

 

Diagram Analysis

• The demand for labour (D_L) represents the demand for workers by firms
• The supply of labour (S_L) represents the supply of labour by workers
• The market equilibrium wage & quantity for truck drivers in the UK is seen at W_eQ_e
• The UK government imposes a national minimum wage (NMW) at W₁
• Incentivised by higher wages, the supply of labour increases from Q_e to Q_s
• Facing higher production costs, the demand for labour by firms decreases from Q_e to Q_d
• This means that at a wage rate of W₁ there is excess supply of labour & the potential for unemployment equal to Q_dQ_s

  

The Advantages and Disadvantages of using Minimum Wages in Labour Markets

Advantages	Disadvantages
Guarantees a minimum income for the lowest paid workers Higher income levels help to increase consumption in the economy May incentivise workers to be more productive	Raises the costs of production for firms who may respond by raising the price of goods/services If firms are unable to raise their prices, the introduction of a minimum wage may force them to lay off some workers (increase unemployment)

• Many public goods and services improve the lives of a country's population
• Governments often provide services to improve the level of equity e.g. healthcare services ensure everyone can access the same medical treatment
   

An Explanation and Evaluation of the State Provision of Public Services

Method	Explanation	Advantages	Disadvantages
State provision of public goods/services	Public goods are beneficial for society and are not provided by private firms due to the free rider problem Examples include roads, parks, lighthouses, national defence	They are usually provided free at the point of consumption Accessible to everyone regardless of income Usually provide both private and external benefits to society	Paid for through general taxation There is an opportunity cost associated with their provision Products which are free may result in excess demand and long waiting times e.g. procedures at Public hospitals

• Legislation is the process of creating laws
• Regulation is the process of monitoring and enforcing the laws
• The use of legislation and regulation are referred to as command and control as it involves ongoing government intervention
   

An Explanation & Evaluation of Government Regulation & Legislation

Method	Explanation	Advantages	Disadvantages
Legislation and Regulation	Governments create rules (laws) to limit harm from the external costs of consumption/production They often create regulatory agencies to monitor that the rules are not broken	Individuals or firms may be fined/imprisoned for breaking the rules e.g. selling cigarettes to minors is a punishable offence They help to reduce the external costs of demerit goods Fines can generate extra government revenue	Enforcing laws requires the government to hire more people to work for the regulatory agencies Enforcing laws can be difficult as it is a complex process to determine if firms/consumers are breaking the laws The regulation may create underground (illegal) markets which could generate even higher external costs on society