Chapter - 2.10.3

• Four of the most commonly used methods to address market failure in markets are indirect taxation, subsidies, maximum prices, & minimum prices

• Additional methods of intervention include regulation, nationalization, privatization, & State provision of public goods

Maximum Prices

• A maximum price is set by the government below the existing free market equilibrium price & sellers cannot legally sell the good/service at a higher price

• Governments will often use maximum prices in order to help consumers. Sometimes they are used for long periods of time e.g. housing rental markets. Other times they are short-term solutions to unusual price increases e.g. petrol

Diagram Analysis

• The initial market equilibrium is at PeQe

  • A maximum price is imposed at Pmax

    • The lower price reduces the incentive to supply & there is a contraction in QS from Qe → Qs

    • The lower price increases the incentive to consume & there is an extension in QD from Qe → Qd

    • This creates a condition of excess demand QsQd 

Minimum Prices

• A minimum price is set by the government above the existing free market equilibrium price & sellers cannot legally sell the good/service at a lower price

  
  

• Governments will often use minimum prices in order to help producers or to decrease consumption of a demerit good e.g. alcohol

Diagram Analysis

• The initial market equilibrium is at PeQe

• A minimum price is imposed at Pmin

  • The higher price increases the incentive to supply & there is an extension in QS from Qe → Qs

  • The higher price decreases the incentive to consume & there is a contraction in QD from Qe → Qd

  • This creates a condition of excess supply QdQs