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“There we re going to take a few minutes in this topic video to think think about an intervention markets. The idea of maximum prices or price ceilings. So many the government world could be an industry regulator can set a maximum price. Which prevents the market price from rising above a certain threshold or a certain level maximum prices have come in the news in recent times.
Lots of topical examples to think about some economists and some politicians arguing. We should introduce introduce read controls in the housing market to improve affordability. There s been a debate about whether or not there should be an energy price cap to keep fuel bills under control and the labor market should we impose a maximum cap on the pay of chief executives and bonuses and financial markets. European union is introduced a cap on roaming charges and text calls in the eu indeed those caps coming down and roaming charges will be abolished from 2017.
The debates about whether there should be a what kind of price. Capping formula should be used for the regional water. Monopoly companies. A couple years ago.
The financial conduct authority introduced a cap on the interest rates that could be charged by payday lenders. Such as one go they kept interest rates at naught point eight percent per day should there be a cap on the charges that are made on occupational pension plans and it s a macro level of course so countries can enjoy can decide to operate with a fixed exchange rate. They can operate a cap on their exchange rate the hong kong dollar for example is currently capped and pegged to the us. Dollar.
That might change so here we re thinking about the economics of price caps maximum prices in in a sector. We re going to work through the analysis in the next couple of minutes. So hopefully. This will be straightforward for you if there s a free market in the economy.
This particular market. It doesn t really matter what it is the market of course reaches equilibrium. Where market supply meets market demand now what about the introduction of a maximum price into this market. Well.
The key point. A key provision. Point is that a maximum price must be set below the normal free market equilibrium. It s going to have any effect on the market.
It must be set below the normal free market. Which of course in our example. Here is p1 and q1 so i m going to put in a maximum price now there it is as my price ceiling and i ve set it below p1. I ve set it a little distance below the equilibrium.
And this of course has consequences. One of the effects is that the price is now lower than it has been that should cause an expansion along the demand curve to q2 consumers want to buy more but producers have less of an incentive to supply at the maximum price. So we might expect to see supply contract from q1 to q3. So as a result of course.
We ve created in the market excess demand equal to the vert. The horizontal distance between q2 and q3 that s the basic economics of a maximum theis. The maximum price of course could be affected. So the excess demand in the market could be affected.
If there s an increase in demand. So i ve now shifted my demand curve out perhaps incomes have risen or has been the change in consumer tastes and preferences. If we hold the maximum price here you can see there s now an even bigger excess demand in the market. So one of the evaluation points.
Could be if you set a maximum price is that a rigid price is it fixed in stone or is it a flexible maximum price to take into account changing conditions for example. The changing market demand curve keep that in mind ok. So now we re going to take the analysis. A little bit further the basic analysis of a price ceiling.
We ve been through you set a maximum price below the free market price. And that creates excess tomate that will get you so far. That s good analysis. Let s just take a little bit further so let s go back to our original diagram here s our maximum price below the free market equilibrium and we ve created an excess demand equal to q2 minus q3.
Now. The key point is if that is the maximum price officially in the market. Then unofficially. If there s only q3 available for people to consume.
There are some consumers who are willing and able to pay price p2. Which of course is much higher than the maximum price that we ve established so you could get the emergence of an unofficial price for like a shadow price above the ceiling. So officially the prices down here unofficially. If the quantity was restricted to q3 the people who are willing to pay up to p2 that s a really key analysis point if you restrict the quantity to q3 some consumers willing to pay an unofficial price of p2 and some producers may decide well that s there s a lot of consumer surplus here that we could possibly extract.
If we can charge a higher price in an unofficial shadow market. And that shaded area here in yellow if you charge p 2. Is the extracted consumer surplus above the official price ceiling it could be the case if q 3 is the only amount that s left in the market. If producers have cut back their supply you need some rationing or some auction process.
If you want to restrict the output to q3 in the absence of an official black market for example. You might have to auction off the or ration in particular rational quantity. So that people the quantity says of q3 in the price stays at the maximum price so it s quite important in your analysis to when you re thinking about a price ceiling to think about the consequences. And if we go back to our diagram here think about consumer surplus.
Think about producer surplus. The basic maximum price diagram is fairly straightforward if you just take your analysis. A little stage further to show the possibility of a shadow or black market. Developing consequences for consumer welfare for tutu.
Prices. Then yes you ve shown the effect of sitting. But i don t wanna gloss over some of the key extra analysis bits thanks for joining in ” ..
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The short revision video looks at price ceilings in markets. A maximum price must be set below the normal free market equilibrium price to have any effect on price and output.
price ceilings, maximum prices, consumer surplus, government intervention, tutor2u