Price Control

Do you eat your fruit and veg daily? Fruits and vegetables are widely accepted as healthy foods that improve the lives of their consumers and increase their health. However, why are healthy foods so expensive than unhealthy foods? That's where price controls come in: the government can intervene in the market to make healthy foods more accessible. In this explanation, you will learn everything you need to know about price controls, including their advantages and disadvantages. And, if you're wondering if there are examples of price controls that will help you understand the topic - we have them for you too! Ready? Then read on!

Price Control Price Control

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Table of contents

    Price Control Definition

    Price control refers to the government's attempt to set a maximum or minimum price for goods or services. This can be done to protect consumers from price gouging or to prevent companies from selling products below a certain price and driving out competitors. In general, price controls aim to regulate the market and promote fairness for all parties involved.

    Price control is a government-imposed regulation establishing a maximum or minimum price for goods or services, usually aimed at protecting consumers or promoting market stability.

    Imagine the government sets a maximum price for a gallon of gasoline at $2.50 to prevent oil companies from raising prices excessively. If the market price for gasoline rises above $2.50 per gallon due to a supply shortage or increased demand, the government will take measures to ensure that prices do not exceed the established limit.

    Types of Price Control

    Price controls can be broadly categorized into two types: price floors and price ceilings.

    A price floor is a minimum price that is set for a good or service, meaning that the market price cannot go below this level.

    An example of a price floor is the minimum wage law in the United States. The government sets a minimum wage that employers must pay their workers, which serves as a price floor for the labor market. This ensures that workers receive a certain level of compensation for their work.

    A price ceiling, on the other hand, is a maximum price set for a good or service, meaning that the market price cannot exceed this level.

    An example of a price ceiling is rent control in New York City. The government sets a maximum rent that landlords can charge for certain apartments, which serves as a price ceiling for the rental market. This ensures that tenants are not charged excessively high rents and can afford to live in the city.

    Want to learn more about price floors and price ceilings? Read our explanations: Price Floors and Price Ceilings!

    When are price controls effective?

    To be effective, price controls must be set in relation to the equilibrium price to be effective, which is called binding, or an ineffective limit is considered non-binding.

    If a price floor, or minimum price, is z the equilibrium price, then there will be no immediate change to the market - this is a non-binding price floor. A binding (effective) price floor will be a minimum price above the current market equilibrium, immediately forcing all exchanges to adjust to the higher price.

    In the case of a price ceiling, a price cap is placed on the maximum good that can be sold. If the maximum price is set above the market equilibrium it will have no effect or be non-binding. In order for a price ceiling to be effective or binding, it must be implemented below the equilibrium market price.

    Binding price control occurs when a new price is set so that the price control is effective. In other words, it has an effect on the market equilibrium.

    Price Control Policy

    An unregulated market can provide efficient outcomes for both suppliers and consumers. However, markets are subject to volatility from events such as natural disasters. Protecting citizens from sharp price increases during turmoil is a critical response to minimize the economic damage to livelihood. For example, if prices were to skyrocket for essential products, citizens would struggle to afford daily necessities. Price control can also mitigate future financial burdens as protecting citizens could prevent them from going into bankruptcy and requiring financial assistance from the state.

    Common responses to regulation in the market typically range from "why do I care about other people's healthy food access" or "how does this help anything." Both concerns should be considered, so let's analyze some possible effects a policy like this might have.

    If more citizens have healthier diets and thus better health, they are likely to be able to work more efficiently and require less time off work for health issues. How many workplaces have employees who missed work or required short to long-term leave due to preventable health issues? In 2019, the United States government spent $1.2 trillion on healthcare.1 Increasing the health of citizens could reduce the necessity for healthcare spending and allow those tax dollars to be spent on other programs or even allow for a possible reduction in taxes.

    Another reason for price controls is that an unregulated market has difficulty addressing externalities. The biggest example is pollution. When a product is created, shipped, and consumed it has varying effects on the world around it, and these effects are difficult to factor into the price. Progressive governments are currently working on regulations to curtail pollution through variations of price control.

    Cigarettes lead to diseases like lung cancer and heart disease. Increases in negative health outcomes raise the financial burden for the governments to pay in healthcare costs, therefore the government can attempt to control this by altering the price.

    Price Control Examples

    The three most common price control measures are related to essential goods. For example, rent prices, labor wages, and medicine prices. Here are some real-world examples of government price controls:

    1. Rent Control: In an effort to protect tenants from rising rents, New York City has had rent control laws in place since 1943. Under these laws, landlords are only permitted to raise rents by a certain percentage each year and must provide specific reasons for any rent increase above that percentage.3
    2. Maximum Price for Medicines: In 2013, the National Pharmaceutical Pricing Authority (NPPA) of India established a maximum price that pharmaceutical companies could charge for essential medicines. This was done to make healthcare more affordable for low-income individuals in the country.4
    3. Minimum Wage Laws: The federal government and many state governments have established minimum wage laws that set a minimum hourly wage that employers must pay their workers. The aim is to prevent employers from paying low wages so workers cannot meet their basic needs.5

    Price Control Economics Graph

    Below is a graphical representation of the two forms of price control and their effects on the supply and demand curve.

    price control price ceiling studysmarter

    Fig 1. - Price Ceiling

    Figure 1. above is an example of a price ceiling. Before the price ceiling, the equilibrium was where the price was P1 and at a quantity of Q1. A price ceiling was set at P2. P2 intersects the supply and demand curve at different values. At P2, suppliers will receive less money for their product and, therefore, will supply less, which is represented by Q2. This contrasts with the demand for the product at P2, which increases as a lower price makes the product more valuable. This is represented by Q3. Therefore there is a shortage in Q3-Q2 from the difference between demand and supply.

    To learn more about price ceilings, check our explanation - Price Ceiling.

    price control price floor studysmarter

    Fig 2. - Price Floor

    Figure 2 illustrates how a price floor affects supply and demand. Before the price floor, the market settled at equilibrium at P1 and Q1. A price floor is set at P2, which changes the available supply to Q3 and the quantity demanded to Q2. Because the price floor increased the price, demand has reduced due to the law of demand and only Q2 will be purchased. Suppliers will want to sell more at a higher price and will increase their supply to the market. Therefore there is a surplus of Q3-Q2 from the difference between supply and demand.

    To learn more about price floors, check our explanation - Price Floors.

    Economic Effects of Price Controls

    Let's explore some of the economic effects of price controls.

    Price controls and market power

    In a perfectly competitive market, suppliers and consumers are price takers, meaning they must accept the market equilibrium price. In a competitive market, every firm is incentivised to capture as much of the sales as possible. A larger firm may try to price out its competition to gain a monopoly, resulting in an inequitable market outcome.

    Government regulation can intervene by setting a price floor, taking away the larger firm's ability to lower its prices to drive out competitors. It's important also to consider the full market effect of any policy; a price floor in a competitive market can inhibit innovation and efficiency. If a firm can't lower its price, then it has no incentive to invest in a way to produce its product for less money. This will allow inefficient and wasteful firms to stay in business.

    Price controls and deadweight loss

    It's important to consider the full economic effects of price controls when implementing them. A change to the market system will affect the whole system and even things outside of it. At any given price of a good, producers determine how much they can supply at the market price. When the market price decreases, the available supply will decrease as well. This will create what is known as a deadweight loss.

    If a price control is enacted to make essential goods available to a segment of the population, how can you be sure that the segment you intended it for receives the benefit?

    Suppose a government wants to provide affordable housing to low-income residents, so they enact a price ceiling limiting the maximum cost of apartments for rent. As discussed before not all landlords can provide apartments at this lower rate, so supply decreases and creates a shortage. An optimistic view would say at least we got some of the citizens in affordable housing. However, it's important to consider factors of how shortages change the market scape.

    A factor in purchasing an apartment is the travel distance to view apartments and how far of a commute to work or groceries an apartment may require. For citizens with a reliable car driving 30 miles to view apartments isn't that inconvenient. However, not all low-income citizens have access to reliable cars. So the shortage is felt worse by those who can't afford to travel long distances. Also, landlords are incentivised to discriminate against a tenant's financial reliability, even if legally protected. Low-income housing may not require a credit check. However, when choosing between tenants, a tenant with a high-end car will appear more financially stable than one who arrived on a bus.

    Price controls and social programs

    Due to the difficulties of shortages when it comes to price controls, many governments have developed social programs that help mitigate the issue of high prices. The various programs are subsidies that help fund otherwise unavailable goods to low-income citizens. This changes the dynamic of price control as it takes the burden off the consumer and producer and instead reappropriates tax dollars to aid in the affordability of goods.

    The free-market equilibrium price of lettuce is $4. The price ceiling lowered the price of lettuce to $3. With the price ceiling in place, farmer Bob can no longer sell his lettuce at $4. Farmer Bob grows his crops on lower-quality land than other farmers, so he must spend extra money just to keep his lettuce growing. Farmer Bob runs the numbers and realizes he can't afford to buy enough fertilizer with the market price of $3, so farmer Bob decides to grow half as much lettuce. A few other farmers, like Bob, can't afford to supply as much lettuce at a lower price, so the total lettuce supplied decreases.

    Economists generally argue against price controls as the benefits struggle to outweigh the cost. While select individuals or firms may initially benefit from the price control, many will have worse outcomes from shortages or surpluses. Additionally, the precision of the aid they are intended to provide is hard to guarantee.

    Advantages and Disadvantages of Price Control

    We have already mentioned some of the most important price control advantages and disadvantages. Take a look at the overview below and then find out more in the following paragraphs.

    Table 1. Advantages and disadvantages of price control
    Price control advantagesPrice control disadvantages
    • Protection for Consumers
    • Access to Essential Goods
    • Reduction in Inflation
    • Possible shortages and black markets
    • Reduced innovation and investment
    • Market distortion
    • Administrative cost

    Price Control Advantages

    The advantages of price control are:

    • Protection for Consumers: Price controls can protect consumers from price gouging by limiting the amount that producers can charge for essential goods and services.
    • Access to Essential Goods: Price controls can help to ensure that essential goods are affordable and accessible to all members of society, regardless of their income level.
    • Reduction in Inflation: Price controls can help to control inflation by preventing excessive price increases for goods and services.

    Price Control Disadvantages

    The disadvantages of price control:

    • Shortages and Black Markets: Price controls can lead to shortages of goods and services as producers are less incentivized to produce them at a lower price. This can also lead to the emergence of black markets where goods are sold at higher prices than the regulated price.
    • Reduced Innovation and Investment: Price controls may lead to reduced investment and innovation in industries where price controls are imposed, as producers may be less motivated to invest in new technologies or processes if they cannot raise prices to recoup their investments.
    • Market Distortion: Price controls can lead to market distortions, which can create inefficiencies and reduce the overall welfare of society.
    • Administrative Costs: Price controls can be costly to administer, requiring significant resources and manpower to enforce and monitor.

    Price Control - Key Takeaways

    • Price control refers to the government's attempt to set a maximum or minimum price for goods or services.
    • Price controls aim to regulate the market and promote fairness for all parties involved in market activity.
    • There are two types of price control:
      • A price ceiling limits the maximum price of a good or service.
      • A price floor sets a minimum price on a good or service.
    • Deadweight loss is the lost efficiency when a natural market equilibrium is disrupted. Identified by a decrease in consumer and producer surplus.

    References

    1. Tax Policy Center, How much does the federal government spend on health care?, https://www.taxpolicycenter.org/briefing-book/how-much-does-federal-government-spend-health-care
    2. Farella, Testing California’s Price Gouging Statute, https://www.fbm.com/publications/testing-californias-price-gouging-statute/
    3. New York State Homes and Community Renewal, Rent Control, https://hcr.ny.gov/rent-control
    4. THE DRUGS (PRICES CONTROL) ORDER, 2013, https://www.nppaindia.nic.in/wp-content/uploads/2018/12/DPCO2013_03082016.pdf
    5. United States Department of Labor, Minimum Wage, https://www.dol.gov/agencies/whd/minimum-wage
    Frequently Asked Questions about Price Control

    What is price control?

    Price control is a limit on how high or low a price can go, imposed by a government to achieve a particular benefit.

    How does price control protect competition?

    A price control such as a price floor can protect competition by setting a minimum price to protect small firms that don't have the efficiencies of scale larger firms have.

    What are the types of price control?

    There are two types of price controls, price floor, and price ceiling. Modified uses of these two have been implemented as well.

    What ways can government control prices?

    Governments can control prices by setting either an upper or lower limit on the cost of a good or service, these are known as price controls.

    What are economic benefits of price control?

    The economic benefit of price control is the suppliers who receive protection from competition or the consumers who receive protection from inflation.

    Why do governments control prices?

    The government controls price to achieve certain economic or social goals, such as protecting consumers, promoting market stability, or ensuring access to essential goods and services.

    How may price control lead to the grey or black market?

    rice control may lead to the emergence of grey or black markets because when the government sets a price ceiling or floor, producers and consumers may seek out alternative channels to buy or sell goods at the market price

    Test your knowledge with multiple choice flashcards

    Which of these is bad for the market?

    The effect a Price Control has on the market is _______?

    The government is looking to set a price ceiling on dirt bikes, the market price is $500, what would be a binding price ceiling?

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