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Price Control and Market Structure Overview
When talking about price controls, the conversation is about limits that are imposed and upheld by the government regarding the amounts in a market that can be charged for products and services. Setting such limits may be motivated by a wish to keep commodities affordable even in times of supply disruptions and to prevent inflation, or even just to guarantee a living wage. When talking about price controls in markets, there are two main types that are seen: price ceilings and price floors.
Price controls are limits that are imposed and upheld by the government regarding the amounts in a market that can be charged for products and services.
Price Ceiling
The highest price that a vendor can ask for a service or product is known as the price ceiling. Price ceilings (also known as price caps) are generally implemented during emergencies like environmental disasters or wars. Why? Because these situations frequently result in unexpected price hikes that harm numerous people while benefiting only a select few.
Fig 1. Price ceiling
In Figure 1 above a price ceiling is set at P2, which keeps the price of commodities down. By doing so the government is attempting to protect buyers from the sellers who are only out to make a profit. However, the downside of this is that there is now a shortage of Q2-Q3 in the market as demand exceeds supply at P2.
Price ceilings are the highest prices that a vendor can ask for services or products. Basically, a price ceiling lowers prices of products and services.
The wartime selling prices that happened during World War II is one example in history of a price ceiling. During this time, the government fixed the cost of numerous commodities, like rubber and paper, below the normal sale price in an attempt to curb inflation and keep prices from increasing too rapidly when there was a shortage of supply and a surplus of demand.
Price ceilings generally result in inefficiency in the shape of wastage of resources: individuals devote wealth, energy, and time to compensate for shortages linked to price ceilings. The inefficiency is also due to the fact that the commodities being supplied are of consistently poor quality: vendors produce poor-quality commodities at a cheap price although consumers would rather pay a higher price to have a high-quality product.
Shortages occur when the demand is greater than the supply of products and services.
Price Floor
The price floor is the absolute minimum cost that consumers must pay for a commodity or service. For example, minimum wage is used as a price floor for the rate of pay that reflects the market price of work. Price floors, similar to price ceilings, are meant to aid individuals but have foreseeable and unfavorable consequences. How? Well, the continuous excess that arises from a price floor generates wasted opportunities that are similar to those created by a price ceiling.
Fig 2. - Price Floor
In Figure 2 above a price floor is set at P2, which raises the price of commodities. In the case of wages this would be the minimum wage and would increase the price that workers receive for their labor. By doing so the government is attempting to protect sellers of the goods and services. In case of workers, they are regarded as the sellers of their labor. However, the downside of this is that there is now a surplus of Q2-Q3 in the market as supply exceeds demand at P2.
A price floor is the absolute minimum cost that consumers must pay for a commodity or service. Price floors raise prices of products and services.
Surpluses occur when the supply is greater than the demand of products and services.
Many industrialized nations, like the USA and the EU, put price floors on agricultural goods in order to safeguard farmers. The price floors motivate farmers to expand production while also bringing in new investors to the business.
The Effects of Price Control on Market Structure
Price restrictions are used by governments to guarantee that products and services are offered at a fair price. The free market model works successfully when there are many well-educated buyers buying from various vendors who are able to create a reputation for having excellent or poor-quality commodities. Because of the rivalry between inventors and consumers, this ensures a more fair price. Unfortunately, moments exist where the information (if any) is unavailable to a minimum of one party, or is overall incorrect.
The government then may establish price limits in order to safeguard people from exploitation. Overall, imposing price controls on a well-off, competitive market hurts the community by lowering the volume of business and incentivizing the wastage of resources. Price controls can also impair quality and generate illegal markets as well.
Examples of Price Control
There are many examples of when price controls are used.
Drug costs, for example, are frequently regulated by governments, especially prices for life-saving drugs such as insulin. Drug firms are frequently chastised for having excessively high pricing and they try to get people to accept the high prices while citing costs of research and patents as reasons for the high costs.
Rent control is also a great example. There are numerous types of rent control, however all take the form of legally enforced rental housing costs that are way below the norm. First, there is a scarcity of rental units as landlords grow less willing to rent at such low prices. Instead, the landlords opt to reside in the flats, rent them to family and friends, or sell them to someone else.
This scarcity causes a slew of issues. For instance, because there is a waiting list of individuals who are looking for a property and landlords are not allowed to refuse based on cost, they will instead discriminate based on anything else. They also tend to request extra money from the renters to be given to them under the table before accepting them as tenants and allowing them to sign a rent contract.
Price Control and Market Structure Mechanism
Price controls are a type of legally-enforced economical interference. They are intended to make items more inexpensive for buyers and are frequently used to guide the market structure mechanism in a specific way. These limits may be thought of as necessary in order to control inflation. Price controls are completely contrary to market forces, which decide prices based on supply and demand.
While price controls might well be justified in terms of cost efficiency and stability, they could actually cause the opposite to be true. Over time, price controls have been shown to cause scarcity, rationing, inferior-quality products, and black markets to sell price-controlled commodities through illicit means. In such cases price controls have an adverse effect on the market structure mechanism.
Examples of Market Structures and Price Controls
There are four different market structures:
- Pure Competition
- Monopolistic Competition
- Monopoly
- Oligopoly
Market structures are how various sectors are categorized and distinguished depending on the extent and nature of rivalry for services and commodities.
Let's take a look at how the effects of price controls differ between them.
Examples of Market Structures and Price Controls: Pure Competition
In a pure competition market, the market forces (meaning supply and demand) dictate the amount of products and services that will be produced, as well as prices established by key market players. The items sold by various businesses are all the same. An example of this would be farm products like corn.
Governments often intervene in agricultural markets in order to reduce volatility of prices that producers of agricultural products receive. This ensures consistent supply of food for the nation and prevents food shortages.
Supply is the amount of goods and services that are available for suppliers to offer buyers.
Demand is the desire of someone to have a certain product or service and being willing to pay for it.
Examples of Market Structures and Price Controls: Monopolistic Competition
Opposite of pure competition, monopolistic competition doesn't really guarantee the lowest potential price of manufacturing. That minor change allows for significant variances in how the firms function within the market. Monopolistic competition companies sell relatively identical items with minor variances that serve as the foundation for their advertising and sales.
Monopolistically competitive markets are often subject to price controls by the government due to negative externalities. Fast food, sugary drinks and cigarettes, for example, would be subject to price controls in order to increase the minimum price that the consumer has to pay in order to reduce consumption of the products that create inefficient social outcomes.
Examples of Market Structures and Price Controls: Monopoly
Monopolies and truly competitive markets are at the opposite corners of the market structure spectrum. But a similarity they have is that both put a focus on promoting profit and reducing costs. In monopoly marketplaces, while ideal competition has numerous rivals, there is only a single supplier. Due to this fact, no competition regarding prices exists.
Monopolies are often subjects of price controls, especially when there is a sole provider in the area in case of utilities, for example. The government needs to ensure that the monopolist does not abuse their position and does not overcharge consumers which could make basic utilities unaffordable for some, thereby exacerbating inequality.
A monopoly is a market where there is only a single supplier that doesn't allow for competition from others.
Examples of Market Structures and Price Controls: Oligopoly
Oligopoly markets have businesses that work collaboratively to reduce competition and control a distinct market or sector. Sizes of these companies can vary. However, the strongest companies frequently are bigger and have patents, money, and resources that they can use to generate obstacles for new companies trying to enter into the market.
Oligopolies are subject of price controls to prevent collusion and anti-competitive behaviour. The governments can limit how much producers can charge on particular products to prevent oligopolists from getting unfair advantage due to collusion.
An oligopoly is a market where only a handful of firms control the market.
Price Control and Market Structure - Key takeaways
- Price controls are limits that are imposed and upheld by the government regarding the amounts in a market that can be charged for products and services.
- Price ceilings are the highest prices that a vendor can ask for services or products. Basically, a price ceiling lowers prices of products and services.
- A price floor is the absolute minimum cost that consumers must pay for a commodity or service. Price floors raise prices of products and services.
- Price restrictions are used by governments to guarantee that products and services are offered at a fair price.
- Price controls are completely contrary to market forces, which decide prices based on supply and demand.
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Frequently Asked Questions about Price Control on Market Structure
What is price control and market structure?
Price controls are limits that are imposed and upheld by the government regarding the amounts in a market that can be charged for products and services.
Market structures are how various sectors are categorized and distinguished depending on the extent and nature of rivalry for services and commodities.
What is an example of price control and market structure?
Price ceiling; Pure competition
What are the effects of price control on market structure?
Price controls have been shown to cause scarcity, rationing, inferior-quality products, and black markets to sell price-controlled commodities through illicit means.
How does the market structure affect pricing?
Price controls are completely contrary to market forces, which decide prices based on supply and demand.
What are pros and cons of price control on market structure?
Pro: price limits are set in order to safeguard people from exploitation.
Con: price controls can impair quality and generate illegal markets.
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