MAXIMUM PRICE REGULATION| | | Nguyen Thi Xuan Quynh – 1001584Nguyen Thi Kim Chau – 1001587| | 24 November 2010| | | INTRODUCTION There are various types of government policy using only the tools of supply and demand. Price control is one of the tools that policymakers usually apply when the market price of a good or service is unfair to buyers or sellers. In this case, the government will intervene to reduce the market’s failure. Economic Intervention has two kinds: * Direct Intervention: the government affects the market price directly in the market for a specific good. * Maximum price regulation. Minimum price regulation. * Indirect Intervention: the Government uses tools to affect the market price indirectly. In this paper, we will concentrate on Maximum Price Regulation. DEFINTION Maximum price: A price ceiling set by the government or some other agency or in other words: It is a legal maximum on the price at which a good can be sold. The price is not allowed to rise above this level (although it is allowed to fall below it). WHY SHOULD PRICE CEILING POLICY BE APPLIED? Price ceiling policy is applied when the market for a necessary good is in equilibrium at a very high price, which may be harmful to the buyers.
Its purpose is to protect buyers; and sellers are not allowed to sell the good at a price higher than the ceiling price set by the government. HOW PRICE CEILINGS AFFECT MARKET OUTCOMES There are two cases: Binding case and Non-binding case: * Binding case: the policy applied to deal with the problem that has already happened. * Non-binding case: the policy applied as a preventive action to avoid the problem that may happen in future. In binding case, the ceiling price creates shortage which means that there are not enough goods to meet the demand in the market. Solutions to the problem of shortage: * Importing * Supporting supply Reduce tax on sellers * Technical supports * Subsidy A price ceiling set below the free-market price has several effects. Suppliers are of course not beneficial from this. As a result, the production will decrease. Meanwhile, consumers find they can now buy the product with large quantity, i. e. the demand increases. These two actions cause demand to exceed supply, which causes a shortage. So, the sellers must ration the scarce goods among the large number of potential buyers. Reduction in quality To supply demand at the legal price, the seller have to reduce the costs and in most cases, lower costs mean lower quality.
Black markets If somebody cannot obtain needed goods because a price ceiling reduces the quantity, they may turn to the black market. Some sellers can profit by illegally selling at a higher price than the free market allows. The black market price is higher than the free market price because the quantity is not enough for the demand in a free market transaction. People are sometimes forced to buy at these higher prices when a shortage happens and there is no other place to obtain these. Discrimination If there is a shortage, sellers may discriminate among customers. EXAMPLES
Apartment price control in Finland In April, 2010, price ceilings on Helsinki City Hitas apartments make no sense (according to professors Niko Maattanen and Ari Hyytinen). They cause queuing, and discriminate against the handicapped, single parents, elderly, and others not able to queue for days. They cause inefficient allocation, as apartments are not bought by those willing to pay the most for them—and those who get an apartment are unwilling to leave it, even when their family or work situation changes, since they can’t sell it at what they feel the market price should be.
These inefficiencies increase apartment shortage and raise the market price of other apartments. Control on ice-cream prices The government, for example, imposes a price ceiling of $4 per cone (while the equilibrium price is $3/cone). In this case, because the price that balances supply and demand ($3) is below the ceiling, the price ceiling is not binding. Market forces naturally move the economy to the equilibrium and the price ceiling has no effect. When the government imposes a price ceiling of $2 per cone, the ceiling is a binding constraint on the market (because the equilibrium price of $3 is above the price ceiling).
At this price, 125 cones are demanded and only 75 are supplied, so there is a shortage of 50 cones, so some people who want to buy ice cream at the going price are unable to. When a shortage of ice cream develops because of this price ceiling, some mechanism for rationing ice cream will naturally develop. The mechanism could be long lines: Buyers who are willing to arrive early and wait in line get a cone, while those unwilling to wait do not. Alternatively, sellers could ration ice cream according to their own personal biases, selling it only to friends, relatives, or members of their own racial or ethnic group.
Notice that even though the price ceiling was motivated by a desire to help buyers of ice cream, not all buyers benefit from the policy. Some buyers do get to pay a lower price, although they may have to wait in line to do so, but other buyers cannot get any ice cream at all. CONCLUSION In general, maximum price regulation is one of the policies that the government come up with to protect the buyers. However, if this policy is not applied flexibly, it can cause some bad effects on the market, both for the suppliers and the consumers.