Effect of Price Floor and Ceiling on Agriculture and Petroleum Industry

Submitted by:
Imran Abdul Qadir (SP12-EX-0060) Shoaib Ahmed (SP 12-EX-0085) Imtiaz Sheikha (SP11-EX-0005) Muhammad Talha (SP11-EX-0004) Faisal Ashraf Ali (SP11-EX-0010)

Submitted To: Mr. Shujaat Mubarak

INTRODUCTION
In this presentation, we have highlighted the effect of price flooring and price ceiling on agriculture and petroleum sector. That whats effects occur on industry. This presentation consist bit introduction of price flooring and ceiling, then some related application alongwith effects indications.

Price Ceiling and Price Flooring

These are usually enacted when policymakers believe the market price is unfair to buyers or sellers. The government can enact

Price ceilings, and Price floors.

PRICE CEILINGS
Price

ceilings that involve a maximum price below the market price create five important effects on industry.
1. 2. 3.

4.
5.

Shortages Reduction in Product Quality Wasteful Lines and Other Costs of Search Loss of Gains from Trade Misallocation of Resources

INDUSTRY WITH A PRICE CEILING

(a) A Price Ceiling That Is Not Binding Price Supply

40

Price ceiling

33
Equilibrium price

Demand

100
Equilibrium quantity

Quantity

SHORTAGES
Price Ceilings Create Shortages
Price Supply

Market Equilibrium Shortage

Controlled Price (Ceiling)

Demand Quantity Qsupplied at the Controlled Price Qdemanded at the Controlled Price

SHORTAGES
1.

When prices are held below the market price shortages are created.

The

shortage = difference between the Qd and the Qs at the controlled price. The lower the controlled price relative to the market equilibrium price, the larger the shortage.

INDUSTRY WITH A PRICE CEILING

(a) The Price Ceiling on product Is Not Binding

Price

Supply, S1 1.When, the price ceiling is not binding . . . P1

Price ceiling

Demand 0 Q1 Qty

INDUSTRY WITH A PRICE CEILING

(b) The Price Ceiling Is Binding

Price

S2
2. . . . but when supply falls . . . S1

P2

Price ceiling P1 4. . . . resulting in a shortage. 0 QS QD Q1

3. . . . the price ceiling becomes binding . . .

Demand Quantity

REDUCTION OF PRODUCT QUALITY

2.

At the controlled price, sellers have more customers than goods.

In

a free market, this would be an opportunity to profit by raising prices. But when prices are controlled, sellers cannot. Sellers respond to this problem in two ways:

Reduce quality Reduce service

WASTEFUL LINES AND OTHER COSTS OF SEARCH

Price Ceilings Create Wasteful Lines
Price Supply Willingness to Pay Time Cost Total Value of Wasted Time Controlled Price (Ceiling) Market Equilibrium

Shortage

Demand
Quantity Qsupplied at the Controlled Price

Qdemanded at the Controlled Price

WASTEFUL LINES AND OTHER COSTS OF SEARCH

3.

Price controls that create shortages lead to bribery and wasteful lines.
Shortages:

not all buyers will be able to purchase the good. Normally, buyers would compete with each other by offering a higher price. If price is not allowed to rise, buyers must compete in other ways.

WASTEFUL LINES AND OTHER COSTS OF SEARCH

Industry will not supply the best and result will be:
I Can Supply you Petrol at low Profit margin.

How

LOST GAINS FROM TRADE

Dead-weight

Loss is the total of lost consumer and producer surplus when all mutually profitable gains from trade are not exploited.
Price ceilings create a dead-weight loss by forcing Qs below the market Q.
and sellers would both benefit from trade at a higher price, but cannot since it is illegal for price to rise.

Buyers

LOST GAINS FROM TRADE

4.

Price controls reduce the gains from trade.

Price

ceilings set below the market price cause Qs to be less than the market Q. When Q is below the equilibrium market Q, consumers value the good more than the cost of its production. This represents a gain from trade that would be exploited (if the market were free).

LOST GAINS FROM TRADE

Price Ceilings Reduce the Gains from Trade
Price Consumer Surplus Shrinks to this Producer Surplus Shrinks to this Willingness to Pay
Consumer surplus in market equilibrium

Supply

Market Price Controlled Price (Ceiling)

Producer Surplus in equilibrium

Shortage

Market Equilibrium

Demand Quantity Qsupplied Qmarket Qdemanded

LOST GAINS FROM TRADE

Price Ceilings Reduce the Gains from Trade
Price

Deadweight Loss (lost gains

from trade) = Lost Consumer Surplus + Lost Producer Surplus
Supply

Willingness to Pay Total Value of Wasted Time

Lost Consumer Surplus Lost Producer Surplus

Market Price

Market Equilibrium

Controlled Price (Ceiling)

Shortage Demand Quantity

Qsupplied

Qmarket

Qdemanded

MISALLOCATION OF RESOURCES
5.

Price controls distort signals and eliminate incentives-- leading to a misallocation of resources.
Consumers

who value a good most are prevented from signaling their preference (by offering sellers a higher price.) So producers have no incentive to supply the good to the right people first. As a result, goods are misallocated.

PRICE FLOORS
Price floor: a minimum price allowed by law.
not

as common as price ceilings (but still important)

Price floors have four common effects:

1.

2.
3. 4.

Surpluses Lost gains from trade (deadweight loss) Wasteful increases in quality A misallocation of resources

PRICE FLOOR SITUATION 01

(a) A Price Floor That Is Not Binding Price Supply Equilibrium price 33

20

Price floor

Demand 0 100 Quantity

Equilibrium quantity

IF GOVERNMENT DO
If the government sets a price floor for butter above the equilibrium market price, what will be the effect? a) Farmers will produce less butter and consumers will purchase more, resulting in a shortage of butter. b) The supply of butter will increase and the demand will decrease. c) Farmers will produce more butter and consumers will purchase less, resulting in a surplus of butter. d) The equilibrium price will rise to the price floor.

21

PRICE FLOOR SITUATION 02

(b) A Price Floor That Is Binding Price Supply Surplus 40 33 Equilibrium price Demand 0 80 120 Quantity Price floor

Quantity Quantity demanded supplied

HOW PRICE FLOORS EFFECT INDUSTRY OUTCOMES

A binding price floor causes . . .

a surplus, because quantity supplied is greater than quantity demanded. non-price rationing, which is an alternative mechanism for rationing the good, using discrimination criteria.

Examples:

The minimum wage, agricultural support price and Royalties.

HOW THE MINIMUM WAGE AFFECTS THE INDUSTRY

Rate

Supply

Equilibrium Wages / Royalties

demand
0 Equilibrium Quantity

HOW THE MINIMUM WAGE / PRICE AFFECTS THE INDUSTRY

Rate
Consequences: 1. Demand falls between 1 and 3 percent for every 10% increase in the minimum wage / Supply support price 2. The total income of consumer rises Some consumer change their requirement Opportunities for sale are reduced A lot of them are from middle-class families

Surplus of stock Minimum Wage

demand
0 Quantity demanded Quantity supplied Quantity

WASTEFUL INCREASES IN QUALITY

Price controls that create surpluses lead to wasteful increases in quality.

Price Deadweight Loss Supply

Controlled Price (Floor) Quality Waste Market Equilibrium

Willingness to Sell

Demand
Qdemanded at the Controlled Price

Quantity

If they cant lower price, sellers will find other ways to compete!

OTHER EFFECTS ON INDUSTRY

The equilibrium quantity increases The price paid by buyers falls

So,

buyers gain sellers gain too

The price received by sellers increases

So,

The total gain = the total subsidy Which side gains how much depends on the price elasticities of demand and supply

27

WASTEFUL INCREASES IN QUALITY

Higher quality raises costs and reduces seller profit. Buyers get higher quality, but would prefer a lower price. Price floors encourage sellers to waste resources:

higher quality than buyers are willing to pay for

SUMMARY
The price floor and ceiling are being necessary to control prices of essentials otherwise not affordable for middle and lower class. It is also effecting to petroleum and agriculture industry badly because they produce essential and government cannot afford high rates of these products.