Government Intervention: Price Controls (AQA A Level Economics)
Revision Note
Written by: Claire France
Reviewed by: Steve Vorster
Using Price Controls to Correct Market Failure
Price controls are a type of government intervention in markets to change the existing market price
To correct market failure, price controls are used to influence the levels of production or consumption in markets that are failing to allocate resources efficiently
Two types of control are commonly used: maximum price (price ceiling) and minimum price (price floor)
Price Ceilings (Maximum Prices)
A price ceiling is a maximum price set by the government. Sellers cannot legally sell the good or service at a higher price
The price ceiling is set below the existing equilibrium market price
Governments will often use price ceilings in order to help consumers if the market price is too high, especially for essential goods and services
Sometimes they are used for long periods of time e.g. rent controls to keep rents lower in housing rental markets
Other times, they are short-term solutions aimed at limiting unusual price increases e.g. petrol
Diagram: Impact of Price Ceiling
The price ceiling (Pmax) sits below the free market price (Pe) and creates a condition of excess demand (shortage)
Diagram analysis
The initial market equilibrium is at PeQe
A price ceiling is imposed at Pmax below the equilibrium level
The lower price reduces the incentive to supply and there is a contraction in quantity supplied (QS) from Qe → Qs
The lower price increases the incentive to consume and there is an extension in quantity demanded (QD) from Qe → Qd
This creates a condition of excess demand (shortage) equal to QsQd
The aim of this policy is to promote equity in the market for essential goods and services and it attempts to solve market failure caused by income inequality
Evaluating the use of Price Ceilings (Maximum Prices)
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Price Floors (Minimum Prices)
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 to help producers or to decrease consumption of a demerit good
In Wales and Scotland, governments have introduced a minimum price of alcohol at 50 pence per unit
Minimum prices are also used in the labour market to protect workers from wage exploitation. These are called minimum wages
Diagram: Impact of a Price Floor
Price floor (Pmin) is set above the free market price (Pe) creating a condition of excess supply (surplus)
Diagram analysis
The initial market equilibrium is at PeQe
A price floor is imposed at Pmin above the equilibrium level
The higher price increases the incentive to supply and there is an extension in supply from Qe → Qs
The higher price decreases the incentive to consume and there is a contraction in demand from Qe → Qd
This creates an excess supply equal to QdQs
In the case of demerit goods, this discourages consumption, reducing output to a level closer to the socially optimal level of output
Evaluating the use of Price Floors (Minimum Prices)
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Examiner Tips and Tricks
Students' often draw maximum and minimum price diagrams the wrong way around. Make sure you can draw both diagrams and show that they can lead to excess supply or excess demand.
You should be able to explain the merits of using price controls and give examples of specific markets where price controls are used by the government.
Always point out that It is difficult for governments to set prices at the ‘correct’ level. Generally, price controls distort the price signals in markets and can worsen the problem rather than solve it, leading to government failure. A more effective solution to maximum prices for rent controls could be increasing the supply of housing.
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