The second in a two-part series that introduces the idea of market equilibrium in economics. Suitable for total beginners to economics, and good revision for those more experienced. In this part: price controls, and how they lead to disequilibrium.

Before reading this, you should have read the first part of this mini-series, which introduces the concept of market equilibrium. In this part, we will look at actions the government can take which can cause disequilibrium: these are known as price controls. The government can impose two types of price controls, which have opposite effects.

Maximum Price

The first type is a Maximum Price, also known as a Ceiling Price. This occurs when the government sets a limit to how much a certain good or service can cost; this price limit is typically introduced below equilibrium price, (otherwise it wouldn’t have an effect, as the maximum price would be above the current price). Such intervention is designed to help consumers by making goods cheaper – let us take a look at one.

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In this situation, the government has imposed a maximum price of P1 for cars in Tanzania, below the market equilibrium price of Pe. However, as you can see, this is a point of disequilibrium: there are Q2 of cars demanded, but only Q1 of cars supplied. This results in a shortage, as there is more demand than supply at this price: the shortage is of Q2 – Q1 cars.

As you can see by this, a maximum price is not without its problems. Generally there are certain mechanisms that deal with a shortage. A common one is ‘queuing’, where people are put on waiting lists for the goods that are in shortage. Another is rationing, whereby each consumer is given a small part of the good being produced, (appropriate in the case of, say, food). A third solution is for the government to subsidise the production of the good: give a sum of money to the company in return to producing the good. A subsidy results in the supply curve of the good shifting out, (i.e. down and right), and this might return the market to equilibrium. The fourth, and most likely solution, is that of a parallel market – also known as a black market.

Minimum Price

The opposite to a maximum price control is – you may have guessed this – a minimum price. Also known as a floor price. This is a price below which the market price cannot fall, and is set above the equilibrium price in order to be effective. Whereas a maximum price is designed to protect the consumer, a minimum price is put in place to protect the supplier of a good, by guaranteeing them a certain level of profit.

As can be seen, the effect is the opposite of a maximum price. There is a surplus, as there is more supplied than demanded – the surplus is of Q2 – Q1. This is a less ‘dangerous’ effect, but still very wasteful. Governments must also have plans to deal with surpluses of goods – one perhaps famous example is the situation that led to Europe having massive stockpiles of food.

Hopefully you have learnt how to combine the concepts of market supply and demand in this mini-series, and use them to show the market equilibriums of goods and services. Look out for more articles that introduce basic economic concepts!