a) Explain how government control the prices using price ceiling and price floor
Price controls can be defined as a mandated legal price that are set by the government for specified
commodities in favor of both consumer & supplier. Moreover, governmental regulations that enacts to
regulate price are also known as price controls.
Price Ceilings
It does means price ceiling is a maximum legal price that can be charged for particular commodity as
enacted by the government. Accordingly, a price ceiling is a situation when the price is less than the
equilibrium price decided by the market demand and supply.
According to this graph, Rs. 3.00 has been recognized as
equilibrium price with the quantity at 30 in the market based on
market forces. However, government has been enacted a price
ceiling as Rs. 2.00 for particular commodity. As a result of that,
quantity of demand has been increased from quantity at 30 to
quantity at 40.
On other hand, quantity of supply has been decreased from quantity at 30 to quantity at 20. It is led to
create shortage of 20 quantities in the market.
Price Floor
that, price floor is a minimum price that can be charged for particular commodity as enacted by the
government. A price floor is a situation when the price is more than the equilibrium price decided by
the market demand and supply.
According to this graph, Rs. 3.00 has been recognized as
equilibrium price with the quantity at 30 in the market based on
market forces. However, government has been enacted a price floor
as Rs. 4.00 for particular commodity. As a result of that, quantity
of supply has been increased from quantity at 30 to quantity at 40.
On other hand, quantity of demand has been decreased from quantity at 30 to quantity at 20. It is led
to create surplus of 20 quantities in the market.
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b) Briefly explain short term and long term effects of imposing price
ceiling/maximum price on Essential Goods
Short Term Effects
Always, a newly imposed maximum price for a commodity is imposed below than the existing
equilibrium of the market. So, it leads to create a shortage in the market due to the excess of
demand. According the graph price ceiling, creates a shortage in coconut supply in between Q1Q2.
Imposing price on an essential goods, creates long queues in the market because consumer tends
to demand in more coconut from the reduced price. But consumers who are not willing to stay for
longer time in the queues tends to purchase the same, even by paying a higher price than the price
ceiling. As a result of that, Black market price is created for coconut in the market in P1
P2
range.
Elasticity of demand & supply for an essential good is always takes inelastic. Hence after imposing
a maximum price in the market, the quantity or the volume of the shortage is less compared to
the long term.
Imposing a maximum price to sell a commodity discourages coconut supplier. It leads to restrict
new industrial investment in the society.
Long Term Effects
In long run, elasticity of demand & supply for an essential good is always takes elastic. Hence after
imposing a maximum price in the market, the quantity or the volume of the shortage is higher
compared to the short run.
If the ceiling price continue until the long run, coconut producers will mobilize their production
resources to substitute products.
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In long run market inefficiencies can be occurred due to low prices for supplier. It leads to reduce
innovation creation in the market.
c) Discuss the challenges faced by Sri Lankan government when implementing
price controls
Although governments introduce Price controls with the objective to improve social outcomes,
governments face challenges due to the short term and long term effects of the controls. The challenges
faced by the Sri Lankan government referring to Price Ceiling and Price Floor situations are elaborated
below. The consequences could be creation of excess demand in the case of price ceilings or excess
supply in the case of price floors.
Price Ceiling
Quantity and quality deterioration: Price ceilings take away profits from potential sellers and
they will react by diminishing the quality of the product. Supplies will decrease in the market.
Creation of Long queues in the market: Sellers will sell the controlled product on a first come
first served basis, and the consumers will have to wait in long lines to buy, thus long lines are
Emergence of black markets: Suppliers are more likely to avoid the price controls established
and move over into the markets where they can sell for a price that's higher than the imposed price
in the market. Eventually Government will have to involve in controlling and mitigation those
markets.
Termination of supplies: Price ceilings demotivates local industries where it limits new producers
entering the market and leads to no or hidden supplies. Manufacturers may also discontinue the
lower priced lines of control imposed products.
Rationing Costs: Governments may have to impose some form of rationing as a solution to
queuing and black markets which may lead to additional cost of regulating policies and monitoring.
Long term effect of inflation: Due to the increased prices of imported goods, a long term effect
of inflation in the economy could occur. Lack of penetrations will retards the economic
development of the country as well.
Occurrence of tie in sale & Forced up trading: Government will have to protect consumers who
may have to purchase unwanted quantities of substitutes to buy the particular control adopted
products. And monitor the manufacturers who may discontinue the low priced lines of the product
and force the consumers to buy the higher priced level of the product.
Price Floor
Unwanted use of scarce resources: Manufacturers will manufacture larger quantity to intersect
their supply curves with the new price where consumers will not buy that quantity of goods at the
higher price and excess use of scarce resources could be wasted and lead to market failure.
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Economic harm on cut back of production: If suppliers look ahead and response by cutting back
the production for the low demand, deadweight loss may occur where the reduction in quantity in
reflected in the loss of consumer and producer surplus at lower levels of production.
Purchase cost on excess production: The Government has to purchase excess production in the
market which leads to an additional cost to be exerted on distribution of excess production.
Cost of subsidizing the producers: The government may have to make payments, Give
production rights and quotas to the producers to keep some portion of their production with the. It
could result in extra cost to the government while production rights may lead to lobbying for the
profitable rights or bribery.
Over Investment situation in the society: The Government will have to put an extra effort in
formulating new economic policies to mobilize excess production among the substitute industries
Economic problem of Unemployment: Minimum wage creates a standard per hour wage that is
mandatory payment for work. Eventually employers start to hire fewer skilled employees to
minimize the wage cost. Accordingly the supply of workers will be higher than the amount of
work in the market, which will lead to unemployment. Hence, the government will have to face
the challenge of decreasing the unemployment rate in the economy.
d) Explain the consequences of imposing a price ceiling for coconut using a
diagram where necessary
Following assumptions have been adapted to present the consequences of imposing a price ceiling for
coconut using a diagram,
Annual yield, 3000Mn coconuts have been considered as equilibrium quantity in the coconut
market before imposing a price ceiling for coconut by assuming total yield is supplied at given
equilibrium prices.
Assumed annual yield, 3000Mn coconuts consist with 1500Mn small size coconuts (a coconut
with a circumference below 12 inches) and 1500Mn large size coconuts (a coconut with a
circumference above 12 inches).
Hence, assumptions have been adapted as equilibrium quantity for small size coconuts is
1500Mn at Rs. 65 per small size coconut (given equilibrium price) in the coconut market before
imposing a price ceiling for coconut whereas equilibrium quantity for large size coconuts is
1500Mn at Rs. 80 per large size coconut (given equilibrium price) in the coconut market before
imposing a price ceiling for coconut.
Price ceiling for small size coconuts is considered as Rs. 50 and price ceiling for large size
coconuts is considered as Rs. 65.
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As an inelastic demand for coconut, assumed the change in quantity demanded as 5% against
to the change in price. Thus, when imposing a price ceiling for both small size coconut and
large size coconut, elasticity can be shown as bellow,
Assumed total shortage is 250Mn coconuts due to imposing a price ceiling for coconut and it
consists with 125Mn small size coconuts and 125Mn large size coconuts.
When imposing a price ceiling for coconut, the consequences can be graphically presented as
bellow based on above assumptions,
According to this graph, Rs. 65.00 (EP) has been
recognized as equilibrium price for small size coconut
with the quantity at 1500Mn (Q) in the market based on
market forces. However, government has been enacted a
price ceiling as Rs. 50.00 (P1) for small size coconut. As
a result of that, quantity demand is increased 5% against
to change in price of small size coconut. Therefore,
quantity of demand has been increased from quantity at
1500Mn (Qd) to quantity at 1575Mn (Qd1).
On other hand, quantity of supplied has been decreased from quantity at 1500Mn (Qs) to quantity at
1450Mn (Qs1) as a reaction of price ceiling for small size coconuts. It is led to create shortage of
125Mn small size coconuts in the coconut market.
According to this graph, Rs. 80.00 (EP) has been
recognized as equilibrium price for large size coconut
with the quantity at 1500Mn (Q) in the market based on
market forces. However, government has been enacted a
price ceiling as Rs. 65. 00 (P1) for large size coconut. As
a result of that, quantity demand is increased 5% against
to change in price of large size coconut. Therefore,
quantity of demand has been increased from quantity at
1500Mn (Qd) to quantity at 1575Mn (Qd1). On other
hand, quantity of supplied has been decreased from quantity at 1500Mn (Qs) to quantity at 1450Mn
(Qs1) as a reaction of price ceiling for large size coconuts. It is led to create shortage of 125Mn large
size coconuts in the market. As a result of price ceiling, coconut suppliers will lose the gain they had
at the EP (loss in producer surplus) and consumer will be benefited (gain on consumer surplus).
Ultimately, the society will face consequences like decrease coconut supplies, discontinuation of coconut
production which will lead to create a market inefficiency. It is indicated as deadweight loss in both graphs.
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References
Gardiner, W. H. (1987). undefined.
Mankiw, N. G. (2008). Principles of economics. Cengage Learning.
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