Another problem is that high prices may cushion inefficiency. Firms may feel less need to find more efficient methods of production and to cut their cost if their costs if their profits are being protected by the high price. Also the high prices may discourage firms from producing alternative goods which are in higher demand, but which nevertheless have a lower (free market) price.
This uncertainty may discourage farmers from making long-term investment plans. A farmer maybe reluctant to invest in, say, a new milking parlour, if in a couple of years it might be more profitable too switch to sheep rearing or arable farming. A lack of investment by farmers will reduce the growth of efficiency in agriculture.
Over the years, farm incomes are likely to decline relative to those in other sectors of economy. What is more, farmers have very little market power. Particular complaint of farmers is that they have to buy their inputs (tractors, fertilizers, etc) from non-competitive suppliers who charge high prices. Then they often have to sell their produce at very low prices to food processors, packers, distributors and supermarkets. Farmers thus feel squeezed from both directions.
The pressure on farm incomes may cause unemployment and bankruptcies; smaller farms may be taken over by larger ones; and generally, as the rural population declines, village life may be threatened-with the break-up of communities and the closure of schools, shops and other amenities.
Competition from abroad
Farming may well be threatened by cheap food imports from abroad. This may drive farmers out of the business.
Price ceiling
Shortage
Price ceiling is the highest price level the government would allow prices to rise clear the market where a condition of shortage exists. (Note that the highest price level here is still lower than the equilibrium price.)
For instance, if the government thinks that people need bread to live, and that the market price of bread is too high, then they might install a price ceiling. Assume that the following graph represents the market for bread. At equilibrium, the price will be p*, and the quantity will be q*.
If the government puts in a price ceiling, we can see that the quantity demanded will exceed the quantity supplied, meaning that not enough bread will be supplied to satisfy demand. Such a situation is called a shortage. Because price ceilings are installed in the interests of the buyers: not being able to afford any bread, or not having enough bread to go round.
The government may set maximum prices to prevent them from rising above a certain level. This will normally be done for reasons of fairness. In wartime, or times of famine, the government may set maximum prices for basic goods so that poor people can afford to buy them.
The resulting shortages, however, create further problems. If the government merely sets prices and does not intervene further, the shortages will lead to the following:
Government will encourage supply by giving subsidies or tax relief to firms. Then the supply will increase and eliminate the shortage. Or reduce demand by offering substitute goods.
The government sets minimum prices to prevent them from falling below a certain level. It may do this for various reasons:
To protect producer’s income. If the industry is subject to supply fluctuation (e.g. crops, due to the fluctuations in weather) and if industry demand is price inelastic, price are likely to fluctuate severely. Minimum prices will prevent the fall in producer’s incomes that would accompany periods of low prices.
If markets for agricultural products were free from government intervention, they would be about as close as one could get prefect competition in the real world. There are thousand of farmers, each insignificantly small relative to the total market. As a result, farmers are price takers.
Government Intervention
Types of government intervention that can be used to ease the problem examined above.
Buffer Stock
Buffer stocks to stabilize the prices
Buffer stock involves the government buying food and placing it in stores when harvests are good, and then releasing the food back on to the market when harvests are bad. They can thus only be used with food that can be stored: i.e. non-perishable foods, such as grains, wine or milk powder and meat. The idea of buffer stocks is a very old way.
What the government does is to fix a price. Assume that this is Pg. At this price demand is Q d. If there are good harvests (Sa1), the government buys up the surplus Qs1-Qs2 from the store on to market.
Subsidies
Effect of subsidies on agricultural products if the country is self-sufficient
The government can pay subsidies or grant tax relief to farmers to compensate for low market prices. Subsidies can be used to increase farm incomes as well as to stabilize them. The simplest form of subsidy is one known as direct income support or direct aid. Here farmers are paid a fixed sum of money irrespective of output. Given that such subsidies are unrelated to output, they do not provide an incentive to produce more.
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An alternative system is to pay a subsidy per unit of output. This, of course, will encourage farmers to produce more, which in turn will depress the market price. The case of an agricultural product where the country is self sufficient. Without a subsidy that the market price down to Pm. The size of subsidy that the government must pay, therefore, will be Pg- Pm. The total amount of taxpayer’s money spent will be the shaded area. The effect of subsidy is to shift the effective supply curve downwards by the amount of subsidy, to S+ subsidy.
Incidence of Tax
Another way in which the government can alter the market is through taxes. One such example is in the tobacco market: if the government would like to discourage the sale and use of tobacco, they would charge tobacco sellers a tax on tobacco products. In most cases, sellers pass as much of the added cost on to buyers as possible because the sellers don’t want to lose any profits, they have to increase their selling price in order to maintain the same profit margin, since they had to pay an extra tax when obtaining the products for resale. In such cases, the supply curve will shift vertically by the exact amount of the tax.
So, if the government charges a $1 tax on every pack of cigarettes, and the cigarette sellers want to pass this tax on the buyers, then the supply curve will shift upwards by $1. The net result is that for any price, the stores will sell fewer packs of cigarettes, to make up for the extra cost of the tax. In effect, if consumers want to maintain their previous levels of consumption, cigarettes would now cost $1 more per pack. However, the new equilibrium shows that prices will be in between p and (p+1), and the quantity will be less than the initial quantity. We can see how this works on the graph above.
Price Control
Price Ceiling In Philippine
Case Study
In the Philippines the basic necessities are like the rice, corn, bread, fresh, dried and canned fish and other marine products, fresh pork, beef and poultry meal; fresh eggs, fresh and processed milk; fresh vegetables; root crops; coffee; sugar; cooking oil; salt; laundry soap; detergents; firewood; charcoal; candles; and drugs classified as essential by the Department of Health of the Philippine. In addition, the Price Act (Republic Act 7581) which is to control the price manipulation happens, it is a tool that is often cited to control price. There are three price manipulations:
The first is hoarding, it is considered illegal under this law and also it is punishable by imprisonment. Hoarding is when the undue accumulation by an individuals or combination of individuals of any basic products beyond his or their normal stock levels or the unjustified taking out any basic necessity from the channel of reproduction, trade, commerce and industry.
Profiteering is the sale or offering for sale of any basic necessity at a price grossly in excess of its true worth.
Cartel is any combination of a agreement between two or more persons engaged in the production, manufacture, processing, store, supply, distribution, marketing, sale or disposition of any basic necessity designed to artificially to increase or to manipulate the price.
Causes of short-term price fluctuations-Rice
A field is not like a machine. It cannot produce a precisely predictable amount of output according to the inputs fed in. The harvest is affected by a number of unpredictable factors such as the weather, pest and diseases. Fluctuating harvests mean that farmer’s incomes will fluctuate.
Shortage
Maximum Price: Price ceiling
The shortage of rice in Philippines will create further problems. If the government merely sets the price and does not intervene the effect will be the following:
The allocation on a ‘first come, first serve’ basis. This is will have the effect of queues develop or adopting waiting list.
The firms that produce rice will decide which customers should be allowed to buy the rice. For instance, giving preferences to regular customers.
Therefore, the solution of this effect is the government will have to adopt a system of rationing. People could be issued with set number of coupons for each item rationed.
Effect of price control on black-markets prices.
A problem with maximum prices is likely to be is the black market, where customers, unable to buy enough rice in legal market, may well prepared to pay very high prices: prices above P e.
To minimize the type of problems that the government will have by reducing the shortage of rice by encouraging supply: by drawing on stores, by direct government production, or by giving subsidies or tax relief to firms that produce rice. Alternatively, it may attempt to reduce demand: by the production of more alternative goods.
Price Ceiling in the United States
CASE STUDY
Rent Control Issues
There are many cities that have rent control. This means that the maximum rent that can be charged is by setting a government agency. But the rent in New York city is usually allowed to rise a certain percent each year to keep up with the inflation. However, the rent is lower than P e.
Shortage
Maximum Price: Price ceiling
Therefore, shortages are typically associated with this price ceiling. In the case of apartments, there are perhaps hundreds of people looking for each apartment that is vacant. Rent controls were supposed to protect those who were renting when the demand for apartments exceeded the supply, and landlords were preparing to “gouge” their tenants.
PROBLEMS
Giving preferences to certain customers:
The landlords often rent to preferred renters. These are likely to be married couples, probably over 30, and without children or pets. If the rent cannot be raised on the apartment, there is nothing preventing the landlord from charging for the parking space, charging for use of the elevator, charging for gardening and cleaning services, forcing the tenants to pay for electricity and water, and so forth. In New York, a rent-controlled apartment near Central Park might rent for $300 to $400 per month; in a free market, the rent would probably be $2,000 per month. To get in, one needs the key. This has been known to cost $1,000. This is not a refundable deposit; this is a charge to have the key. It is obviously worth it to be able to rent the apartment for $300 to $400 per month.
SOLUTION:
Price ceilings provide a gain for buyers and a loss for sellers.
Effect of price control on black-markets prices.
Sellers would like to avoid the loss if they can. One way to do so is called a black market. In this case, the sellers illegally raise the price and hope to get away with it. Shortages create a rationing problem -somehow, it must be determined who will get the product and who will not. There are many ways to resolve the shortage problem. The most common way is first-come, first-served. Shortages are typically associated with long lines. In the case of apartments, there are perhaps hundreds of people looking for each apartment that is vacant.
The allocation on a ‘first come, first serve’ basis. This is will have the effect of queues develop or adopting waiting list.
Giving preferences to certain types of customers to rent the apartment.
Therefore, the solution of this effect is the government will have to adopt a system of rationing. People could be issued with set number of coupons for each item rationed.
Where necessary, government can increase rental subsidies to low-income tenants or a change in the tax policy could be enacted.
The Price Floor in Brazil
Case Study
Sugar
Surplus
Minimum Price: Price floor
PROBLEM
The production of sugarcane in order to produce sugar. There is always fluctuation in price for in sugar in Brazil. Therefore, a field is not like a machine. It cannot produce a precisely predictable amount output of sugarcane to produce sugar. The harvest of sugarcane is affected by a number of unpredictable factors such as the weather, pest and diseases. Fluctuating harvests mean that farmer’s incomes will fluctuate. The government of Brazil sets the minimum price to prevent them from falling below a certain level. It may do this various reasons:
To protect producers’ income of sugar firms.
To create a surplus which can be stored for future shortage of sugar.
SOLUTION
The government will use various methods to solve the surpluses of sugar:
The government will buy the surplus sugar and store it, destroy it or sell it abroad in other markets.
Supply of sugarcane will be artificially lowered by restricting producers of sugar to certain quotas.
The demand of sugar could be raised by advertising, and finding alternative uses for the goods, or by reducing the consumption of the substitute goods of sugar.
Other effect of price floor is that firms with surpluses on their hands may try to evade the price control and cut their prices. Another effect is that high prices may cushion inefficiency. Sugar firms may feel less need to find more efficient methods of production and to cut their cost if their costs if their profits are being protected by the high price. Also the high prices may discourage firms from producing alternative goods which are in higher demand, but which nevertheless have a lower (free market) price.
Price Floor in Republic of China
Case Study
Airline Tickets
The public hearing on the price floor scheme for Chinese airlines can serve as a useful litmus test of the aviation administration’s commitment to market rules. However, the price floor that the authorities have already established in the draft plan indicates that faith in market competition.
Surplus
Minimum Price: Price floor
PROBLEMS
The price floor hearing has been rescheduled for today due to the outbreak of severe acute respiratory syndrome (SARS) in April. The ramifications of the potentially fatal epidemic on the aviation sector understandably aroused much public sympathy in the past two months. Fortunately, the country’s initial triumph over the SARS outbreak in late June has allowed representatives to the hearing to concentrate again on the essentials of the price-reform scheme.
SOLUTION
Fortunately, the country’s initial triumph over the SARS outbreak in late June has allowed representatives to the hearing to concentrate again on the essentials of the price-reform scheme. In their draft plan, the aviation authorities have squarely pointed out three existing faults in the sector — an inflexible pricing system that does not meet market demand, vicious price wars among Chinese airlines and irregular agency business.
However, the solution produced by those who wrote the draft is, sadly, so misguided that the progress of market-oriented aviation reform could be delayed, if not destroyed. By limiting the airline companies’ ability to raise prices at will, the authorities are commendably defending the interests of consumers. According to the draft plan, a maximum discount of 40 percent and a maximum price increase of 25 percent will be imposed on the basic price of 0.75 yuan (9 US cents) per person per kilometer.
The government will use various methods to solve the surpluses of air tickets:
The demand of air ticket could be raised by advertising, and finding alternative ways to tackle the problem, or by reducing airline travel to overseas and domestic.
Other effect of price floor is that firms with surpluses on their hands may try to evade the price control and cut their prices.
Another effect is that high prices may cushion inefficiency. Airline firms may feel less need to find more efficient methods of production and to cut their cost if their costs if their profits are being protected by the high price. Also the high prices may discourage firms from producing alternative goods which are in higher demand, but which nevertheless have a lower price.
CONCLUSION
There are several ways in which the government intervenes in the operation of markets. It can fix prices, tax or subsidize products, regulate production, or produce goods directly itself. The government may fix minimum or maximum prices. If a minimum price is set above the equilibrium, surplus will result. If a maximum price is set below the equilibrium price, a shortage will result.
Minimum prices are set as means of protecting the incomes of suppliers or creating a surplus for storage in case of future reduction in supply. If the government is not deliberately trying to create a surplus, it must decide what to with it.
Maximum prices are set as means of keeping prices down for the customer. The resulting shortage will cause queues, waiting lists or the restriction of sales by firms to favored customers. Alternatively, the government could introduce a system of rationing. With maximum prices, black markets are likely to arise .This is where goods are sold illegally above the maximum prices.
Generally price controls distort the working of the market and lead to over supply or shortage. They can exacerbate problems rather than solve them. Nevertheless there may be occasions when price controls can help for example, with highly volatile agricultural prices.
Despite the fact that free market is agricultural produce would be highly competitive, there is larges scale government intervention in agriculture throughout the world. The aims of intervention include preventing or reducing the fluctuations, encouraging greater national self-sufficiency, increasing farm incomes, encouraging farm investment, and protecting traditional rural ways of life and the rural environment generally. Besides that, airline tickets and also apartment rentals are intervene by the government including preventing fluctuation in the pricing of airline tickets and encouraging firms to be more self sufficient.
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Price fluctuations are the results of fluctuating supply combined with price-elastic demand. The supply fluctuations are due to the fluctuation in the harvest. The demand for supply is generally income inelastic and thus grows only slowly overtime. Supply, on the other hand, has generally grown rapidly as a result of new technology and new farm methods. This puts downward pressure on price- a problem made worse for farmers by the price inelasticity of demand for food.
Government intervention can be in the form of buffer stock, subsidies, price support, quotas, and other ways of reducing supply, and structural policies. Buffer stock can be used to stabilize price. They cannot be used to increase farm incomes over time. Subsidies will increase farm incomes but will lower consumer prices to the world price level (or to the point where the market clears).
DEPARTMENT OF AGRICULTURE
(A) Basic Necessities
• rice
• corn
• cooking oil
• fresh, dried fish and other marine products
• fresh eggs
• fresh pork, beef and poultry meat
• fresh milk
• fresh vegetables
• root crops
• sugar
(B) Prime Commodities
• fresh fruits
• dried pork
• dried beef and poultry meat
• fresh dairy products not falling under basic necessities
• onions, garlic
• fertilizer (chemical and organic), pesticides, herbicides
• poultry, swine and cattle feeds
• veterinary products for poultry, swine and cattle
DEPARTMENT OF HEALTH
(A) Basic Necessities
• drugs classified as essential by the DOH
(B) Prime Commodities
• drugs not classified as essential by the DOH
DEPARTMENT OF ENVIRONMENT AND NATURAL RESOURCES
(A) Basic Necessities
• fire
• charcoal
(B) Prime Commodites
• Plywood
• Plyboard
• Nipa Shingles
• Sawali
DEPARTMENT OF TRADE & INDUSTRY
(A) Basic Necessities
• canned fish and other marine products
• processed milk
• coffee
• laundry soap
• detergent
• candles
• bread
• salt
(B) Prime Commodities
• flour
• processed and canned pork
• processed and canned beef and poultry meat
• noodles
• vinegar, patis, soy sauce
• toilet soap
• paper, school supplies
• cement, clinker, G.I. Sheets
• hollow blocks
• construction nails
• batteries, electrical supplies, light bulbs
Penalty for Violation of Price Ceilings
Any person who violates Section 6 or 7 of this Act shall suffer the penalty of imprisonment for a period of not less than one (1) year nor more than ten (10) years, or a fine of not less than Five thousand pesos (P5,000) nor more than One million pesos (1,000,000), or both, at the
discretion of the court.
Mandated Price Ceiling
Mandated Price Ceiling shall refer to the price imposed on any basic necessity or prime commodity by the President upon recommendation of the implementing agency or the Price Coordinating Council if any of the following conditions so warrant;
Impending existence or effects of a calamity
Threat, existence or effect of an emergency
Prevalence of widespread acts of illegal manipulation
Impendency, existence or effect of any event that cause artificial and unreasonable increase in prices of said commodities.
Automatic Price Control”
Automatic Price Control shall refer to a situation where prices of basic necessities which, unless otherwise declared by the President, are automatically frozen at prevailing prices in areas which have been declared under any of the following conditions:
state of disaster
state of emergency
state of rebellion
state of war
privilege of writ of habeas corpus suspended The term disaster or calamity shall include those brought about by natural or man made cause, whether local or foreign.
Panic buying
Panic buying is the abnormal phenomenon where consumers buy basic necessities and prime commodities grossly in excess of their normal requirement resulting in undue shortage of such goods to the prejudice of less privileged consumers.
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