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Flashcards in Max and Min Price Deck (14)
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1

Maximum Price definition

a legal limit on the highest price that can be charged.

2

Maximum Price facts

- Imposed below the normal equilibrium price.
- Government considers the equilibrium price to be too high.
- Also called a “price ceiling”.
- Has no effect if set at or above equilibrium.
- Examples: Rent controls (housing), Staple foodstuffs (e.g. bread, rice), Transport fares (e.g. public bus transport)
Utilities (e.g. electricity, water).

3

Advantages of Maximum price

- Lower prices for merit goods and necessities goods prices: increases consumption and positive externalities, especially useful to low income earners..
- Reduces monopoly power: especially useful when applied to utilities where there is a lack of competition.

4

Disadvantages of Maximum price

- Shortages: excess demand at the lower price, means rationing will need to occur.
- Costly to Govt: may need to supply the shortage itself or provide subsidies to firms to supply the shortage.
- Queuing: waste of time, opportunity cost.
- Black markets: buy at the maximum price and re-sell at a higher price to those unable to buy it.
- Lower prices for everyone: the rich benefit from lower prices too.
- Market forces are distorted: unable to reach equilibrium.
- Less investment: lower prices reduce profits, which discourages investment.
- Deadweight welfare loss: economic inefficiency.

5

Maximum Price Evaluation

- Must be set below equilibrium to have any effect.
- Involves the government making a normative judgement about the equilibrium price and a “better” maximum price.
- Interferes with the signalling, rationing and incentive functions of the price mechanism, which leads to inefficient outcomes.
- Open to political manipulation.
- More effective when used with other policies (e.g. subsidies).
- Overall impact depends on PED and PES (see next slide).

6

Maximum price with Elastic PED and PES

Larger shortage
Large extension in demand.

7

Maximum price with Inelastic PED and PES

Smaller shortage
Small extension in demand.

8

Minimum Price definition

a legal limit on the lowest price that can be charged.

9

Minimum Price facts

- Imposed above the normal equilibrium price.
- Government considers the equilibrium price to be too low.
- Also called a “price floor”.
- Has no effect if set at or below equilibrium.
- Examples: Demerit goods (e.g. alcohol, tobacco), Wages (e.g. minimum wage), Some imported goods (to help domestic producers)

10

Minimum Price advantages

- Higher prices for demerit good: reduces consumption and lowers negative externalities.
- Higher wages: useful when applied to low paid jobs.

11

Minimum Price disadvantages

- Surpluses: excess supply at the higher price, leads to greater resource use and scarcity.
- Costly to Govt: may need to buy up and store the surplus, which causes an opportunity cost.
- Black markets: poorer consumers may search for cheaper alternatives of a lower standard.
- Higher prices for everyone: the poor might be unable to afford the higher prices.
- Market forces are distorted: unable to reach equilibrium.
- Deadweight welfare loss: economic inefficiency.

12

Minimum Price Evaluation

- Must be set above equilibrium to have any effect.
- Involves the government making a normative judgement about the equilibrium price and a “better” minimum price.
- Interferes with the signalling, rationing and incentive functions of the price mechanism, which leads to inefficient outcomes.
- Open to political manipulation.
- More effective when used with other policies (e.g. indirect tax).
- Overall impact depends on PED and PES (see next slide).

13

Minimum Price with Elastic PED and PES

Larger excess supply
Large contraction in demand.

14

Minimum Price with Inelastic PED and PES

Smaller excess supply.
Small contraction in demand.