Copyright 2006 – Biz/ed Government Intervention in Markets Buffer Stocks Income Guarantee Schemes and Price Controls

Copyright 2006 – Biz/ed Buffer Stocks

Copyright 2006 – Biz/ed Government Intervention in Markets Buffer Stocks: –Influencing market supply through holding or releasing stocks to stabilise prices or incomes –Short term measure –Used in agriculture where supply can be volatile –Assumption: supply is perfectly inelastic in short run –Only useful where goods can be stored!

Copyright 2006 – Biz/ed Government Intervention in Markets Buffer Stock to stabilise price Price Quantity Bought and Sold D Target Price TP Government sets a target price (TP) S (Bad harvest) After a bad harvest, government releases 50 onto market S (Good Harvest) 160 After a good harvest the government ‘buys up’ 60 units and puts them into store

Copyright 2006 – Biz/ed Income Guarantee Schemes

Copyright 2006 – Biz/ed Government Intervention in Markets Income stabilisation Schemes: Buffer stocks do not guard against volatile incomes Aim to ensure farm incomes remain relatively constant – manipulate price through releasing stocks or adding to stores

Copyright 2006 – Biz/ed Government Intervention in Markets Income stabilisation schemes Price per ton Quantity Bought and Sold D 100 S 10 Assume average yearly supply = 100 Farm incomes = £1000 per ton Desired income level = £1000 per ton D1 (PED = -1) D1 shows combinations of P and Q that would maintain incomes at £1000 per ton S – Bad harvest S1 80 In a bad harvest, supply falls to 80 To keep incomes constant, government releases fifteen onto market – price rises to Income Level = £1000 per ton S – Good harvest S2 125 In a good harvest supply increases to 125 (S2) Government buys up 13 units - prices fall to Income levels maintained at £1000 per ton

Copyright 2006 – Biz/ed Government Intervention in Markets Problems of such schemes: –Farmers do not respond to market signals - market becomes distorted –Overproduction if incomes guaranteed –Moral issues of storing food –Cost of storage –Imperfect knowledge of the market –Long term sustainability, international effects – LDCs, World Trade Organisation

Copyright 2006 – Biz/ed Government Intervention in Markets Price Controls: Maximum prices below normal equilibrium Price Quantity Bought and Sold D S £ Assume the equilibrium price is £10 and the amount bought and sold is 100 £6 P Max The government imposes a maximum price of £6 (P Max) Suppliers reduce the amount offered to 60 but demand would rise to 140 creating a shortage of 80 – rationing might have to be introduced Black Market Price £18 Shortages may lead to black market prices way above the equilibrium free market level

Copyright 2006 – Biz/ed Government Intervention in Markets Price Controls: Minimum prices set above normal equilibrium Price Quantity Bought and Sold D S £5 200 Assume initial equilibrium price = £5, and amount bought and sold = 200 £9 Min P Government imposes minimum price of £9 (Min P) At the higher price, demand would fall whereas supply would rise – a surplus would exist. Example – Minimum Wage Legislation in the UK – in theory should lead to unemployment but in reality?