1. Maximum and Minimum Prices
DP Economics

2. 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.

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

4. 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

5. 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.

6. 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

7. 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.)

8. 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

9. 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)

10. 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

11. 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