Price controls − maximum price
This lesson focuses on the impact of a maximum price on the market for a good or service. At first glance many of your students may be supportive of a maximum price on certain goods and services. This is because the benefits of price controls for certain products seem obvious − who wouldn't want to pay less for the goods and services that they purchase? However, an important lesson which your classes need to take out of the next few pages is that price controls also have disadvantages. When considering the benefits and costs of price controls your classes must consider the impact on a range of stakeholders as well as the opportunity costs of such a decision.
The impact of price ceilings on the market for a good or service? Why do governments provide a maximum price for certain products and not others?
Lesson time: 70 minutes
Understand why governments impose price ceilings, and describe examples of price ceilings, including food price controls and rent controls.
Illustrate using a diagram the impacts of a price ceiling on market outcomes.
Examine the possible consequences of a price ceiling, including shortages, inefficient resource allocation, welfare impacts, underground parallel markets and non-price rationing mechanisms.
Discuss the consequences of imposing a price ceiling on the stakeholders in a market, including consumers, producers and the government.
Calculate the possible effects of the price ceiling diagram, including the resulting shortage and the change in consumer expenditure (which is equal to the change in firm revenue) - HL only.
1. Draw two demand and supply diagrams on the whiteboard. Draw the equilibrium price and quantity and then on the first diagram, shade in the area of consumer and producer surplus. Then on the second draw a maximum price, below the equilibrium price and again draw the consumer and producer surplus. What do your students notice about the difference between the two diagrams? Who benefits from the price ceiling?
While the free market will generally lead to the most efficient allocation of any product there will be occasions when the market does not necessarily produce the best outcome for either consumers or producers. In this situation price controls maybe applied by governments. Price controls come in two types - maximum price controls and minimum price controls.
Watch the following power point presentation which compares both maximum and minimum prices. Price controls
Price controls - a price intervention applied by governments. Price controls come in two types - maximum price controls and minimum price controls.
Maximum price / price ceiling - when a government sets a maximum price, below the equilibrium price. This forms a price ceiling for the good or service. Firms cannot charge beyond this price and the policy is designed to protect consumers from exploitation.
Shortage - when the market for a good or service is not in equilibrium because demand for the product is greater than supply.
Rent controls - a price ceiling applied to the rental housing market.
The activities are available as an PDF worksheet at: Maximum price
The diagram to the right illustrates the market for bread in a middle income nation. The government decides to place a maximum price on the product.
(a) Illustrate the effect of the price ceiling on the market for bread.
(b) Indicate the size of the bread shortage resulting from the price ceiling.
(c) One solution to the shortage is for the government to provide a subsidy for the product. Illustrate this on your diagram.
(d) What is the opportunity cost of the decision to make a direct payment to the bread companies?
(e) Why might a government impose a price ceiling on certain public services e.g. public transport, internet, power or water supplies.
Watch the first half of this short video (up to 1.50 minutes) and then complete the activity which follows:
(a) How does a price ceiling effect both producer and consumer surplus?
(b) Why must the price ceiling be drawn below the equilibrium price level?
Activity 3: Rental controls
A government wishes to impose rent controls on housing in its capital city. This is an attempt to increase the quantity of low cost housing available for rent.
(a) Illustrate the effect of the maximum rental price on a supply and demand diagram, illustrating the area of shortage, following the rent control.
(b) Outline the impact of the rent controls on the following stakeholders:
i. Home owners who wish to rent out their properties
ii. Low income tenants
iii. Wealthy tenants wishing to locate a new house in a popular district within the city
iv. House builders based in the city
(a) Watch the following two short videos and then decide whether rental controls, in areas of high demand for housing are effective or not?
Firstly, the argument in favour of rent controls:
And now for the alternative view:
(b) Are there other policies that might be effective in improving the affordability of housing in high demand areas?
Cities where renting a place to live absorbs half of the average salary
Available as a Prezi at: City housing
Activity 5: Price ceilings for premier events
During the 2012 Olympics tickets to the premium events were heavily over subscribed. This was particularly true for the main athletic events, where tickets were sold on the black market for three or four times their face value. The government response was to impose strict limits on ticket sales, with customers limited to a maximum of two tickets per customer.
(a) Draw a supply and demand diagram for the premier athletic events, illustrating the impact of the maximum 2 ticket per customer policy.
(b) Analyse the benefits and costs of the above policy. Who benefits and who loses out from restricting sales to 2 tickets per person?
(c) What other policies could the Olympic organisers have implemented to reduce the excess demand for certain events?
Watch the following short video and then answer the questions that follow:
(a) Draw a price ceiling on the diagram and illustrate the change in consumer and producer surplus.
(b) Illustrate the size of the deadweight loss as a result of the price ceiling.
(c) Explain why the price ceiling has created deadweight loss.
Watch the following video on the impact of price controls on a macro economy and then decide whether or not price controls can ever be effective in a modern economy?
Activity 8: HL only (linear equations are the old syllabus only)
Demand and supply for bread in a middle income country is represented by the following functions: QS = - 2 + (5P), QD = 23 - (5P)
Demand (million loaves)
Supply (million loaves)
(a) Complete the table by adding in the missing blank spaces and highlight the equilibrium price.
(b) Illustrate the above information on a demand and supply diagram, using the graph paper included.
(c) The government decides to impose a price ceiling of $ 1.5, on the product, in an attempt to make the good affordable for more households. Illustrate this on the diagram, indicating the area of shortage and the size of the deadweight loss.
(d) To correct the deadweight loss the government decides to place a subsidy on the good. Illustrate this on the diagram and calculate the cost of the subsidy.
(e) Describe the opportunity cost of the government subsidy?
Activity 9: Link to the assessment
Typical paper one question:
Explain using a diagram how the introduction of a maximum price may impact on the market for food. [10 marks]
Using real life examples, evaluate the advantages and disadvantages of a government decision to impose a price ceiling on rental property within a city. [15 marks]
Further reading on this subject can be accessed at: Uber