CHAPTER 3

Government Microeconomic
Intervention

Maximum and Minimum Prices

Prepared by Ms Viky
Course: AL-ECO
Today`s Discussion
• Meaning and the effect on the market
 3

Introduction
• There are several types of government intervention on
market equilibrium.

• The form of interventions are fixing higher or lower

limit on prices in certain markets and imposition of
taxes and subsidies for certain items.

• This type of government intervention in the market can

be explained using demand and supply analysis.
Government Intervention
• The main reasons why government intervene market:

▫ To correct market failure: it is necessary for

government to provide public goods and merit goods, as

these goods will be underprovided in free market.

▫ Market failure: free market does not make best use of

scarce resources.

▫ Improve the efficient in allocation of resources.

▫ To achieve equal income and wealth distribution.

Methods of Government
Intervention
1. Regulation: various means by which government
seeks to control production and consumption.
• Rules and laws that applies to firms to control the
free market.
• Uses legal or other methods such as control of
price, quality and quantity of goods and services
that are produced or consumed.
• E.g. doctor prescription to buy controlled drugs.
Regulation
Methods of Government
Intervention
• Advantage of regulations:

• Disadvantage of regulations:
Methods of Government
Intervention
2. Financial intervention: use of taxes and
subsidies.
• Government uses taxes and subsidies as a financial
tools to influence the production and price of
the goods or services in an economy.
• Tax: charges imposed by government on
incomes, profits and some types of consumer
goods and services to fund their expenditure.
▫ E.g. stamp duty, income tax, GST, service tax etc.
Methods of Government
Intervention
2. Financial intervention: use of taxes and subsidies.
• Subsidies: a direct payment or grants by
government to producers, make the price paid by
consumer less than it should be.
▫ Subsidies goods and services that benefit
community and might not provide under free
market.
▫ E.g. certain food, public transports, free school
meals for kids from low income families.
Methods of Government
Intervention
3. Government provision / direct provision
• Government to take over the production of goods or
services, either in part or in whole.
• Supply the goods or services directly to customer
free of charge.
• State owned industries: electricity, water provision,
railways.
• Also applies to those industries supplied by both
public and private sectors: education, hospitals.
Maximum Price
• Maximum price (price ceiling): legal maximum on

the price at which a good or service can be sold and

market price must not exceed this price.

• Valid in markets where the maximum price is below

the normal equilibrium price determined in a free

market.

• Government enforce maximum price for:

▫ Staple food, rents in certain types of housing, services

provided by utilities, transport fares.

Maximum Price
Price

Pe

Pmax Maximum price

Q1 Qe Q2 Quantity

Maximum price
Maximum Price
• Market equilibrium in a free market is at PeQe.
• Government impose maximum price at Pmax.
• At Pmax, market supply at _________, market demand
at _________.
• This leads to _________________.
• As price cannot rise, continue to supply at ________.
▫ This is inefficient as too few resources are
allocated.
Maximum Price
• Impact of maximum price
1. Inefficiency / shortages: distort market equilibrium
as there is excess demand and shortages in supply
for the good or service.
• Government impose maximum price on rented
accommodation could create homelessness, as
shortages in supply means some customer unable
to get the product at all.
Maximum Price
Maximum Price
• Impact of maximum price
2. Existence of black market: due to excess demand,
some consumers are prepared to purchase at a
higher price in black market to get the good or
service.
• This creates incentives to develop black market
where people trade the good or service illegally.
• E.g. market for sporting tickets, rock concerts.
Maximum Price
• Impact of maximum price
3. Queue: people will have to queue to purchase the
good or service before it sells out.
• Rationing as a mean of restricting demand –
allocating the good or service on a “first come first
serve” basis.
• Suppliers could also distribute the good or service
only to preferred customers.
Activity 1
Task
Can you work out the value/level of some real-world
maximum prices in this game?
• Energy price caps introduced in the UK in 2019, will be removed
in what year?
• Since 2015, landlords in many German towns and cities can not
set rent for new tenants by more than how much above the
average?
• In 2019, the price of international mobile phone calls between
callers based in EU countries was capped at what rate per
minute?
Minimum Price
• Minimum price (price floor): legal minimum on the
price at which a good or service can be sold, market
must not go below this price.
• Valid in markets where the minimum price is above
the normal equilibrium price determined in a free
market.
• Government enforce minimum price for:
▫ Demerit goods, wages in certain occupations usually low
skilled, certain types of imported goods to protect
domestic producers.
Minimum Price
Price

S
Pmin Minimum price

Pe

Q1 Qe Q2 Quantity

Minimum
price
Minimum Price
• Market equilibrium in a free market is at PeQe.

• Government impose minimum price at Pmin.

• At Pmin, market supply is at _______, market

demand is at _______.

• This leads to ______________.

▫ As price cannot fall, supply restricted to Q1 – this is

all consumer can afford to buy.

Minimum Price
• Impact of minimum price:

1. Over-supply in the market and leads to inefficient.

2. Higher prices for consumer

3. If consumers continue to buy at Q1 and producers

are supplying at Q2, producers will have the

pressure to lower the price back to Pe to clear the

excess supply.
Activity 2
Task
Use the web to find out if there is a minimum
wage in your country. If there is, try to answer
the following questions.

• What is the level of the minimum wage?

• What age does it start at?
• Are there any exceptions where employers are
allowed to pay below the minimum wage?
 24
Maximum and Minimum
Price
Minimum Price Maximum Price
- Other name: Floor Price, Price - Other name: Ceiling Price, Price
Support Control
- Price is not allowed to fall - Price is not allowed to rise
- Also known as minimum price - Also known as maximum price
- Surplus occurs - Shortage occurs
ADVANTAGES ADVANTAGES
- Protects producer`s income - Consumers purchases products
- Higher wage rate at a lower price
DISADVANTAGES DISADVANTAGES
- Consumer`s pay more - Emergence of black market
- Waste of resources of production - Reduces quantity produced
- Creates unemployment - Producers tend to receive illegal
payments from consumers
 25
Maximum and Minimum
Price
Minimum Price Maximum Price

Price Price

Surplus S
S

P2
Min Price
P* P*
Max Price
P2

D Shortage D
Quantit
Quantit
y
y
Key Terms
Key Terms Explanation

Market Where the free market does not make the best use of
Failure scarce resources
Regulation Various means by which government seeks to control
production and consumption
Taxes Charges imposed by government on incomes, profits and
some types of consumer goods and services to fund their
expenditure
Maximum A price that is fixed; the market price must not exceed this
price price
Minimum A price that is fixed, the market price must not go below
price this price
Questions For Practice
a) Distinguish between maximum and
minimum prices.[4]

b) Using a diagram, explain the effects of the

introduction of a minimum price for
cotton on:
i cotton farmers [4]
ii clothing manufacturers. [4]