A minimum price above equilibrium and a maximum price below it: the effects on the economy

The market without intervention. In a competitive market the price settles where the quantity buyers want equals the quantity sellers offer. Above that price there is excess supply and the price tends to fall; below it there is excess demand and the price tends to rise. Governments sometimes step in to control a price because they think the market price of a good is too high or too low compared with the level they want. The two actions in the question are the two forms this takes. To trace their effects, we use our own schedule for the wheat market of a state (price in ₹ a quintal, quantity in lakh quintals a month):

Left alone, the market clears at ₹2,400 with 80 lakh quintals bought and sold.

(i) A minimum price fixed above the equilibrium price.

• What it is and why it is fixed. A minimum price, or price floor, is a lower limit set by the government on the price that may be charged for a good or service. It is used where a fall in price below some level is thought undesirable, and it is normally set above the market price. Its aim is to protect producers whose market price would be too low to cover their costs and leave a small profit, so that they keep producing. Support prices for farm crops are the leading example.
• Excess supply. Suppose the state fixes ₹2,600. Farmers, now offered more, are willing to sell 90 lakh quintals, while buyers, now asked to pay more, want only 70. A floor above the equilibrium price thus creates an excess supply, here a surplus of 20 lakh quintals.
• Effects on buyers and sellers. Buyers pay ₹200 more a quintal and buy less, 70 lakh quintals against 80. Farmers receive the higher price on what they sell, which is the purpose of the floor.
• Under a crop support price, the government takes up the surplus. At the floor, 20 lakh quintals find no private buyer. If nothing is done, sellers would cut their price and the floor would break down; in an agricultural price support scheme such as this one, the government buys the surplus at the fixed price to stop the price falling. Here that means buying 20 lakh quintals at ₹2,600, a bill of ₹520 crore a month (20,00,000 × 2,600), before any cost of storing or disposing of the grain. These funds have other uses, so the floor has an opportunity cost for the economy.
• The labour market. A minimum wage law works the same way: the wage rate is not allowed to fall below a set level, which is fixed above the equilibrium wage. At that wage more people offer to work than employers wish to hire. Here the government does not buy up the surplus; the excess supply of labour simply shows up as people who cannot find work at the legal wage.

(ii) A maximum price fixed below the equilibrium price.

• What it is and why it is fixed. A maximum price, or price ceiling, is an upper limit set by the government on the price of a good or service. It is generally placed on necessities such as wheat, rice, kerosene and sugar, and fixed below the market price, because at the market price some people could not afford them.
• Excess demand. Suppose instead the state fixes a maximum of ₹2,200. Buyers now want 90 lakh quintals but sellers offer only 70. A ceiling below the equilibrium price creates excess demand, here a shortage of 20 lakh quintals.
• Less is actually available. Buyers can obtain only what sellers are willing to supply at the controlled price, so 70 lakh quintals are traded, 10 fewer than in the free market. A measure meant to help consumers can end up leaving the market short of the good.
• Rationing. With the price no longer free to share out the limited quantity, the government may ration it: households receive coupons that cap how much each can buy, and the good is sold through fair price shops.
• Queues. Buyers have to stand in long lines at the ration shops.
• Black market. Many buyers are not satisfied with the quantity they get from the fair price shop and are willing to pay more than the legal price, which may give rise to a black market.

The two compared.

When a control has no effect. A control changes the outcome only when it binds. In the schedule a minimum price of ₹2,200 or a maximum price of ₹2,600 would leave the market at ₹2,400 and 80 lakh quintals, since the free-market price already meets the limit. It is a floor fixed above, or a ceiling fixed below, the equilibrium price that creates excess supply or excess demand.

Conclusion. (i) A minimum price above equilibrium raises the price for sellers but creates a surplus; under a crop support price the government buys and holds it at a cost, while in the labour market it leaves some workers without jobs. (ii) A maximum price below equilibrium lowers the price for buyers but creates a shortage, which brings rationing, queues and a black market. In both cases the price stops balancing demand and supply, and less is bought and sold privately than in the free market.