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A level economics teacher explains price controls

Equilibrium price and quantity

Students should appreciate that a free market equilibrium works through demand and supply to create an equilibrium. This ensures that there is no shortage or surplus in the market. Equilibrium price is also called the market clearing price because it clears the market, i.e. the quantity demanded equals quantity supplied. So there’s no excess demand or supply. Equilibrium point is the one at which there is neither upward nor downward pressure on price. At the price/output of pe, qe, there is no excess demand (nothing to cause price to rise) nor is there any excess supply (nothing to cause the price to fall). The market is in equilibrium.

Minimum price or price floor

Price controls imply that the government (or some government entity) intervenes in the free market to dictate (set) the market price. Student should note that price controls will create a market distortion and reduce market welfare. Recall that total social surplus is the sum of consumer and producer surplus. This is maximized at the free market equilibrium. Any other equilibrium through a price control will reduce the total surplus to the society, hence reduces the total welfare.

If the government force the price to go higher (above Pe) then producers would be willing to supply a higher quantity, while some consumer would be priced of the market, reducing their quantity demanded. A higher price than equilibrium price would therefore create excess supply or a surplus.

excess supply price floor minimum price

As shown in the diagram above, this market equilibrium does not maximize total surplus of the society. Producers end up producing more than buyers are willing to buy. The unsold surplus is going to create a black-market where sellers will be forced to sell the extra output, perhaps at lower prices. Book a session with our A-level economics tutor in London or work online to cover minimum maximum prices, wage controls, price ceilings and price floors in detail.

Deadweight loss

Price controls also create a deadweight loss, which is loss due to inefficiency. In this case, the inefficiency is caused by setting a price floor which is above the market equilibrium price. The graph below shows a shaded region that illustrates the deadweight loss. This is the loss to the society. Consumers were able to buy the good at Pe are not able to purchase at Pmin, hence they lose their surplus and get priced out of the market. Deadweight loss is caused my any market distortion including taxes, subsidies, price floors and price ceilings. Our a-level economics tutor in London will work with you to go over each of these scenarios which is usually tested in the exam.

Price floor with deadweight loss

Maximum price control or price ceiling

This is the opposite of a price floor. In this case, the government sets a price below the market equilibrium price (as shown in the diagram below). When the price is set below market equilibrium, this will reduce the quantity supplied but increase the quantity demanded, leading to a shortage of the good. Market will be out of equilibrium, and there will be a deadweight loss. Can you figure out the shaded region of this deadweight loss? Book a free demo lesson with our a levels economics tutor to learn more.

price floor explained by a level economics coach


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