Question

Some economists feel that unemployment can be reduced by lowering the minimum wage rate. In other words, they believe that the minimum wage rate acts as a price floor (for labour) set by the government that results in excess supply of labour in the market.

a) with the aid of diagrams and suitable examples discuss the economic effect of price controls.

b) With the aid of relevant examples distinguish between administered prices and price controls.

Answer 1

a) In economics, a government intervention on prices or a price control comes in two flavors: a price ceiling and a price floor.

A price ceiling is where the government fixes a maximum price for a good, whereas a price floor is where the government sets a minimum price below which price is not allowed to fall. These interventions usually act as market failures because they change or distort behaviour for agents. More specifically, for a price ceiling, the government can set a price below the equilibrium market price (binding ceiling), resulting in higher demand for the product. At this lower price, consumers demand more, but producers will supply less. As a result, there is excess demand for the commodity. This imposes a dead weight loss on the society, as all possible gains from trade may not have been realized fully. A suitable example for a price ceiling would be rent control that result in housing shortages.

Similarly, a price floor would be minimum support prices that governments set for farmers to help support their livelihoods. This causes excess supply since it becomes cheaper for farmers to produce the goods, but consumers might have to pay more for the same goods.

b) Administered prices or regulated prices are prices that are prices that are not purely determined by market forces. Commonly found in industries with low levels of competition and uniform price structure. Examples of administered prices would be price controls that improve the affordability of certain products or prevent price gouging. In general, administered prices are impervious to market fluctuations and do not depend on the short run changes in supply or demand. They are mostly rigid in nature and can lead to excessive non price competition.