Maximum and minimum prices, buffer stocks, regulation and provision

Last time

Before we start: last time, in Price elasticity of demand and total revenue, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

Controlling prices and markets

Besides taxes and subsidies, governments can fix prices, store goods to stabilise prices, provide goods directly, regulate, and inform. Each tool has benefits and costs. This lesson covers them all.

A maximum price

A maximum price, set below equilibrium at 3 dollars, makes the good cheaper, but creates a shortage of 4 units, as 7 are demanded and only 3 supplied. Shortages lead to queues, rationing and black markets.

Maximum prices: evaluation

Consumers who can buy gain from the lower price, so it can help the poor afford necessities such as food and rent. But those who cannot buy, because of the shortage, lose out; and a black market may charge even higher prices. So a maximum price does not benefit all consumers.

A minimum price

A minimum price, set above equilibrium at 7 dollars, raises producers' income, but creates a surplus of 4 units. The government may have to buy the surplus, at a cost.

Minimum prices and wages

Minimum prices support farmers' incomes, or discourage consumption of demerit goods such as alcohol. A minimum wage is a minimum price for labour: it raises low pay, but may cause unemployment if set too high. Surpluses waste resources and cost the government money to store or destroy.

Buffer stocks

A buffer stock scheme sets a target price band for a commodity, such as wheat. When a good harvest pushes the price below the band, the agency buys and stores the crop. When a bad harvest pushes it above, it sells from its stocks. This stabilises prices and farmers' incomes.

Problems of buffer stocks

Storage costs are high, and perishable goods cannot be stored for long. If the price band is set too high, stocks build up and the scheme runs out of money. A series of bad harvests can empty the stocks. So schemes are hard to run well.

Direct provision, regulation and information

Direct provision: the state supplies goods itself, such as schools and hospitals, free or cheap. Regulation: laws and rules, such as pollution limits, minimum ages and bans; it changes behaviour directly. Information: campaigns and labelling correct information failure, shifting demand.

Can one tool change both demand and supply?

Regulation can act on both sides: limiting what firms supply and what consumers may buy. Information mostly shifts demand; taxes and subsidies mainly shift supply. So the best tool depends on whether the problem lies with buyers, sellers, or both, and on enforcement costs.

Mistakes that lose marks

Mistake one: drawing a maximum price above equilibrium, where it has no effect. Mistake two: saying a buffer stock buys when prices are high. Mistake three: describing a tool without its costs. The fix: correct diagram, correct mechanism, and evaluation.

The full-marks tip

The full-marks tip: draw price controls on the correct side of equilibrium, and show the shortage or surplus. Evaluate each tool: who gains, who loses, and the cost to government.

On one card

So, on one card: price controls and regulation. Keep it for revision.