Maximum and Minimum Prices DP Economics

Maximum Prices Governments can legally set a maximum price in a market that suppliers cannot go above.* To be effective a maximum price has to be set below the free market price. The price for wheat is a good example of maximum price setting when a shortage of wheat threatens a very large rise in the free market price Other examples include rent controls on properties – for example the complex system of rent controls still in place in Manhattan.

Illustrating the effects of a maximum price Rent £s Free Market Equilibrium Supply Pe Demand Quantity of Rented Property

Illustrating the effects of a maximum price Rent £s Supply Free Market Equilibrium Pe P max Price (Rent) Ceiling Excess Demand The Government can set a legally imposed maximum price in a market that suppliers cannot exceed – in an attempt to prevent the market price from rising above a certain level. To be effective a maximum price has to be set below the free market price. Demand Q2 Q1 Quantity of Rented Property

Black markets A parallel market can occur when the normal market price is higher than a legally imposed price ceiling (or maximum price). Black markets develop where there is excess demand (or a shortage) for a good/ service. Some consumers are prepared to pay higher prices in black markets in order to get the goods or services they want. When there is a shortage, higher prices act as a rationing device in the free market.

Potential black market for a good/ service Price £s Supply Free Market Equilibrium P1 Red area is a potential black market* Pe P max Price Ceiling Excess Demand It is worth noting that a price ceiling set above the free market equilibrium price would have no effect whatsoever on the market – because for a price floor to be effective, it must be set below the normal market-clearing price. Demand Q3 Q2 Q1 Quantity

Examples of black markets* Tickets for major sporting events, rock concerts Black markets for children’s toys and designer products that are in scarce supply Black market for the anti-impotence drug Viagra and its new rival products now coming onto the market Black markets in the illegal distribution and sale of computer software products and pirated DVDs and music (the maximum price is zero! Or even negative if you include fines.)

Minimum prices Governments can legally set a minimum price in a market that suppliers cannot go below. To be effective the minimum price has to be set above the normal equilibrium price A good example of this is minimum wage legislation currently in force in the UK* The main adult rate for the minimum wage in the UK is now £5.05 per hour

Illustrating the effects of a minimum price Wage Rate (W) Labour Supply Excess supply of labour due to the minimum wage Wmin Minimum Wage (Wage Floor) We A minimum price is a legally imposed price floor below which the normal market price cannot fall. To be effective the minimum price has to be set above the normal equilibrium price Excess unemployed willing to work Demand for Labour E3 Ee E1 Employment of Labour (E)

Main justifications for the minimum wage* The equity justification: Fair rate of pay commensurate with the skills and experience of an employee Labour market incentives: The NMW is designed to improve the incentives for people to start looking for work Labour market discrimination/ exploitatation The NMW is a tool designed to offset some of the effects of persistent discrimination of many low-paid female workers and younger employees

Disadvantages of a minimum wage Competitiveness and Jobs: A minimum wage may cost jobs because a rise in labour costs makes it more expensive to employ people. Effect on relative poverty:* The greatest risk of relative poverty is among the unemployed, elderly and single parent families where the parent is not employed. They don’t benefit from the NMW Rising prices due to supply costs increase