price controls

Government Intervention in Markets – A‑Level Economics (Cambridge 9708)

1. Why Governments Intervene (Syllabus 1.1)

• Market failure – the market does not allocate resources efficiently.
  • Negative & positive externalities
  • Public goods & common‑pool resources
  • Information asymmetry
  • Monopoly / imperfect competition
• Equity & redistribution – reduce inequality, alleviate poverty, improve social welfare.
• Stabilisation – smooth short‑run volatility in key markets (e.g., agriculture, housing).
• Political & social objectives – consumer protection, national security, employment, regional development.

2. Main Instruments of Intervention (Syllabus 1.2)

For each instrument you should know: how it works, the typical objective, and the main advantages & disadvantages.

3. Price Controls in Detail (Syllabus 1.3)

3.1 Definition

A direct government intervention that sets a legally binding maximum (price ceiling) or minimum (price floor) price for a particular good or service.

3.2 Types of Price Controls

• Price ceiling – set below the market equilibrium price (P_c < P*).
• Price floor – set above the market equilibrium price (P_f > P*).

3.3 Economic Effects of a Price Ceiling

1. Quantity effect: At P_c demand exceeds supply → shortage of size Q_d − Q_s.
2. Welfare effect: Consumer surplus rises for those who obtain the good, but total surplus falls because mutually beneficial trades are lost → dead‑weight loss (DWL).
3. Rationing: Allocation shifts from price to non‑price mechanisms (queues, first‑come‑first‑served, coupons, favoritism).
4. Black‑market activity: Sellers may sell the good illegally at the equilibrium price, earning a “shadow” price.
5. Quality deterioration: Producers cut costs to stay in business, leading to lower quality or reduced service.

3.4 Economic Effects of a Price Floor

1. Quantity effect: At P_f supply exceeds demand → surplus** of size Q_s − Q_d.
2. Welfare effect: Producer surplus rises for sellers who can sell at the higher price, but total surplus falls → DWL.
3. Government intervention: To avoid waste, the state may purchase the surplus (e.g., agricultural price‑support schemes) or let it be discarded.
4. Storage & disposal costs: Surpluses can create costly stock‑piling, spoilage, or “dumping” (e.g., excess wheat dumped at sea).
5. Distributional impact: Higher prices are regressive – they hurt low‑income consumers while benefiting producers.

3.5 Evaluation Checklist (AO3) – Price Ceilings vs. Floors

3.6 Real‑World Examples

• Rent control – New York, London, Berlin: ceiling on residential rents → chronic shortages, reduced maintenance, emergence of illegal “key‑money”.
• Minimum wage (UK National Living Wage) – a price floor in the labour market; see Section 6.
• Agricultural price‑support (EU CAP) – floor on farm‑gate prices; leads to surplus production, storage, and “set‑aside” schemes.
• Fuel price caps (e.g., Venezuela) – extreme ceiling → severe shortages, long queues, and thriving black markets.

4. Government Failure (Syllabus 1.4)

• Definition: Intervention creates a less efficient outcome than the market would have produced.
• Common causes
  • Information problems – policymakers lack accurate, up‑to‑date data.
  • Political pressure – interest‑group capture, electoral cycles.
  • Administrative costs – monitoring, enforcement, bureaucracy.
  • Unintended behavioural responses – “perverse incentives”, rent‑seeking.
• Consequences
  • Dead‑weight loss greater than the original market failure.
  • Misallocation of resources, reduced innovation.
  • Fiscal burden on the Treasury (e.g., subsidies, purchase of surpluses).

5. Equity, Equality & Redistribution (Syllabus 2.1)

• Equality – identical treatment of all individuals (e.g., flat tax rate).
• Equity (fairness) – different treatment to achieve a more equal outcome (e.g., progressive tax).
• Poverty
  • Absolute poverty – living below a fixed standard of living.
  • Relative poverty – living below a set percentage of median income.
• Redistributive policies
  • Progressive income tax.
  • Means‑tested benefits (Universal Credit, Housing Benefit).
  • Negative Income Tax (NIT).
  • Universal Basic Income (UBI).
  • Public provision of health, education, and social care funded by taxation.
• Evaluation criteria for equity policies
  • Targeting accuracy – does the policy reach the intended group?
  • Administrative cost and complexity.
  • Incentive effects – welfare trap, labour‑supply disincentives.
  • Overall impact on poverty and inequality (Gini coefficient, poverty rates).

6. Labour‑Market Interventions (Syllabus 2.2)

6.1 Minimum Wage (Price Floor in Labour Market)

• Sets a legal minimum hourly pay.
• Intended to raise living standards for low‑paid workers.
• Possible effects:
  • Higher worker surplus for those who retain employment.
  • Potential unemployment for low‑skill workers if P_min > equilibrium wage.
  • Reduced wage competition among firms; possible increase in automation.

6.2 Trade‑Union Activity

• Collective bargaining can push wages above equilibrium (similar to a minimum wage).
• May improve working conditions but can also lead to reduced employment in the sector.

6.3 Monopsony Power

• When a single (or few) employers dominate the labour market, they can set wages below competitive levels.
• Government‑imposed minimum wage can correct the inefficiency and raise both employment and wages.

6.4 Training Subsidies & Apprenticeships

• Subsidise the cost of education or on‑the‑job training.
• Shift the labour‑supply curve rightward (more skilled workers).
• Help reduce structural unemployment and increase productivity.

6.5 Employment Protection Legislation (EPL)

• Regulates hiring, firing, and redundancy procedures.
• Increases job security (equity benefit) but can reduce labour‑market flexibility and increase unemployment.

7. Structured Evaluation Framework (AO3 – Cambridge)

1. Identify market characteristics – elasticity of demand & supply, per‑unit cost, storage possibilities, perishability, number of firms.
2. State the policy objective – efficiency, equity, stabilisation, revenue generation, etc.
3. Analyse the direct economic effects – impact on price, quantity, consumer surplus, producer surplus, government revenue/expenditure, DWL.
4. Consider unintended consequences – shortages, surpluses, black markets, rent‑seeking, quality changes.
5. Assess administrative feasibility & fiscal cost – monitoring, enforcement, budgetary implications.
6. Evaluate equity & distributional impact – who gains, who loses, regressive/progressive effects.
7. Compare with the most appropriate alternative instrument – e.g., tax/subsidy vs. price control, regulation vs. market‑based solution.
8. Conclude – under what conditions the policy is likely to be effective or ineffective, and whether the benefits outweigh the costs.

8. Suggested Case Studies for Revision (Syllabus 3)

• Rent control in major cities – New York, London, Berlin: impact on housing supply, quality, informal sub‑letting, and black‑market rents.
• UK National Living Wage – effects on employment, poverty, business costs, and regional disparities.
• EU Common Agricultural Policy (CAP) – price‑support schemes, market‑distorting effects, WTO challenges, and environmental “greening” measures.
• EU Emissions Trading System (ETS) – tradable permits for carbon, price formation, and effectiveness in reducing emissions.
• Universal Basic Income pilots – Finland (2017‑18) and Kenya (2020‑present): impact on labour supply, poverty, administrative costs, and public acceptance.
• Fuel price caps in Venezuela – extreme price ceiling, chronic shortages, and emergence of a parallel market.

9. Diagrams to Include in Revision Notes

• Supply & demand with a price ceiling below equilibrium – show shortage (Q_d > Q_s) and DWL.
• Supply & demand with a price floor above equilibrium – show surplus (Q_s > Q_d) and DWL.
• Tax on producers – leftward shift of supply; illustrate CS, PS, tax revenue, and DWL.
• Subsidy to consumers – rightward shift of demand; illustrate changes in surplus and DWL.
• Externality diagram – marginal private cost vs. marginal social cost; corrective Pigouvian tax.
• Monopsony labour market – supply curve, marginal factor cost (MFC) above supply, effect of a minimum wage.
• Supply & demand with a quota – vertical line at Q_max, resulting price rise and DWL.

10. Key Points to Remember (Quick‑Recall)

• Government intervention is justified by market failure, equity, stabilisation, or political goals.
• Price controls are a *direct* tool: ceilings create shortages; floors create surpluses. Both generate dead‑weight loss.
• Evaluation must always cover: market characteristics, unintended consequences, administrative/fiscal cost, equity, and comparison with alternatives.
• Other instruments (taxes, subsidies, quotas, regulation, property rights, nudges) often achieve the same objectives with different trade‑offs.
• Equity policies aim to redistribute income; success depends on targeting, incentive effects, and administrative efficiency.
• Labour‑market policies have both efficiency and equity dimensions; the minimum wage is a classic example of a price floor.
• Always conclude by stating the conditions under which the policy is likely to be effective and whether it is the *best* option available.