Price and Quantity Regulations

Many markets are, for a number of reasons, regulated. The government could for instance decide about prices that the market is not allowed to go above or below, or about maximum quantities. Such regulations will benefit certain groups of people, but often have unintended negative side effects. These are often called secondary effects.

Minimum Prices

Minimum prices (also called price floors) are often used for wages (the price of labor) and for certain types of goods such as agricultural goods. The minimum price is usually chosen above the equilibrium price, as in the opposite case it would not have any effect. (The market participants would then choose p* instead.) Consumers and producers are consequently prevented from reaching the equilibrium price p*.

Look at Figure 2.4. The effect of the minimum price is that the consumers only demand the quantity Q2 whereas the producers supply the quantity Q1. Therefore, we get an excess supply of the good. Note that consumers and producers are allowed to buy and sell at any price above the minimum price. A price higher then pmin will however result in an even larger excess supply, so typically the minimum price is chosen. The situation described is not an equilibrium. To see that, note that point 2 in the definition of an equilibrium is not satisfied: Given the price pmin producers want to sell the quantity Q1, but that is not possible since the consumers only want to buy the quantity Q2.

Maximum Prices

Maximum prices (also called price ceilings) are in several countries used for apartment rentals. For a maximum price to have any effect, it has to be below the equilibrium price, and the effects are the opposite to those of a minimum price. In Figure 2.5, pmax is the maximum price. It causes the consumers to demand the quantity Q1 whereas the producers only want to supply Q2, and, consequently, that the search time to find an appropriate good is increased since the supply is too small to meet the demand.