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

Quantity of Rented Property

Demand

Supply

Pe

Free Market Equilibrium

Illustrating the effects of a maximum price

Rent£s

Quantity of Rented Property

Demand

Supply

P max

Q1

Pe

Price (Rent) Ceiling

Q2

Free Market Equilibrium

Excess Demand

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/ servicePrice

£s

Quantity

Demand

Supply

P max

Q1

Pe

Price Ceiling

Q2

Free Market Equilibrium

Excess Demand

Q3

P1 Red area is a potential black market*

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 priceWage Rate (W)

Employment of Labour (E)

Demand for Labour

Labour Supply

Wmin

E1

We

Minimum Wage (Wage Floor)

EeE3

Excess supply of labour due to the minimum wage

Excess unemployed willing to work

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