Economics (NCERT) Notes

5.8 Applications of Supply-Demand Analysis

Government intervention in the form of price control
•Often, it becomes necessary for the government to regulate the prices of certain goods and services when their prices are either too high or too low in comparison to the desired levels.
•These regulations impact the market for these goods within the framework of perfect competition 
Price Ceiling
•Sometimes government fixes a maximum allowable price for certain goods.
•The government-imposed upper limit on the price of a good or service is called price ceiling.
•Price ceiling is generally imposed on necessary items like wheat, rice, kerosene, sugar and it is fixed below the market-determined price 
•We shall examine the effects of price ceiling on market equilibrium through the example of market for wheat.
Effect of price regulation
•Figure shows the market supply curve SS and the market demand curve DD for wheat.
•The equilibrium price and quantity of wheat are p* and q* respectively.
•When the government imposes price ceiling at pc which is lower than the equilibrium price level, there will be an excess demand for wheat in the market at that price.
•The consumers demand qc kilograms of wheat whereas the firms supply qc' kilograms
Effect of price regulation
•Hence, though the intention of the government was to help the consumers, it could end up creating shortage of wheat.
Effect of Price control
•When there is shortfall of supply, governments distribute it to everyone, through a system of rationing.
•Ration coupons are issued to the consumers so that no individual can buy more than a certain amount of wheat and this stipulated amount of wheat is sold through ration shops which are also called fair price shops.
Adverse effects of rationing
•Each consumer has to stand in long queues to buy the good from ration shops.
•Since all consumers will not be satisfied by the quantity of the goods that they get from the fair price shop, some of them will be willing to pay higher price for it. This may result in the creation of black market.
Price Floor
•For certain goods and services, fall in price below a particular level is not desirable and hence the government sets floors or minimum prices for these goods and services.
•The government imposed lower limit on the price that may be charged for a particular good or service is called price floor.
•Most well-known examples of imposition of price floor are agricultural price support programmes and the minimum wage legislation.
Purpose of Floor Price
•Through an agricultural price support programme, the government imposes a lower limit on the purchase price for some of the agricultural goods and the floor is normally set at a level higher than the market-determined price for these goods.
•Through the minimum wage legislation, the government ensures that the wage rate of the labourers does not fall below a particular level and here again the minimum wage rate is set above the equilibrium wage rate.
Effect of Floor Price
•Figure shows the market supply and the market demand curve for a commodity on which price floor is imposed.
•The market equilibrium here would occur at price p* and quantity q*.
•But when the government imposes a floor higher than the equilibrium price at pf , the market demand is qf  whereas the firms want to supply qf
This leads to an excess supply in the market equal to qf qf’ 
•In the case of agricultural support, to prevent price from falling because of excess supply, government needs to buy the surplus at the predetermined price.  

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