Price ceilings and price floors: the effects of the government in a market.

HOW GOVERNMENT CAN AFFECT MARKETS

In a free competitive market, as we have seen in the lecture about equilibrium, the price of a commodity is pushed for various reasons to be equal to the equilibrium and therefore to reach an equilibrium in the market. In that equilibrium the quantity demanded and the quantity supplied are equal and both the sides of the market are fully satisfied. There are however some government regulations that can influence the market price thus creating a situation of disequilibrium in the market. The regulations a government can impose on the market can be price ceilings and price floors. A price ceiling sets the maximum price of a commodity in the market whereas a price floor sets the minimum price at which a commodity can be traded. A price ceiling could be applied for example by the government to the housing market, regulating that a house can not be rented for more than a certain amount per month. A classical example of a price floor could be the minimum wage established in underdeveloped countries to avoid an excessive exploitation of the labor force.

WHAT HAPPENS IN CASE OF A PRICE CEALINGS

When a price ceiling is applied we can distinguish two cases:

• The price ceiling is set above the equilibrium price. In this case the price ceiling has no effect because buyers in the market have no incentive to trade at a price above the equilibrium one.

• The price ceiling is set below the equilibrium price. Consider the market for slices of pizza and suppose that the equilibrium price is 3$ for a slice. If government imposes that a slice can be sold for a maximum of 2$, then, because the price decreases, according to the law of demand, there will be more demand for a slice of pizza but, according to the law of supply, less offer. In this case we have a shortage: some people are willing to buy the good but there is not a sufficient supply to satisfy each customer. This means that some mechanisms to ration the good will arise. Such mechanisms could be for example the creation of long lines, unfair choices of the sellers such as selling the product first to their family, friends or people belonging to their racial, ethical or religious groups. This means that in this case the market has become inefficient and unfair.

WHAT HAPPENS IN CASE OF A PRICE FLOOR

When a price floor is applied we can to distinguish two cases once again:

• The price floor is below the equilibrium price. In this case the price floor has no effect because sellers in the market have no incentive to trade at a price below the equilibrium one.

• The price ceiling is above the equilibrium price. consider once again the market for slices of pizza and suppose that the equilibrium price is 3$ for a slice. If government imposes that a slice can be sold for a minimum price of 4$, then, because the price rises, according to the law of demand, the quantity demanded will decrease but, according to the law of supply, sellers will offer to the market a higher quantity of the good. In this case we have a surplus: some sellers are willing to sell the good but there are not enough buyers willing to acquire those products. Also in this case some unfair mechanisms could arise: buyers could decide to buy products only from members of their family (if they sell the good), members of their racial, ethical or religious communities. The market becomes, once again, inefficient and unfair.

By contrast, a perfectly competitive market is fair, efficient and impersonal because everybody who is willing to buy a certain product at a certain price can do so (because quantity offered = quantity demanded).