Inappropriate Prices

1
Inappropriate Prices

• Sometimes society thinks prices are too high or
  too low for the good of everyone
• Price too high may be an essential item, or
  deemed good for society but inaccessible to
  those on low incomes (merit goods or positive
  externalities)
• Price too low consumption may give rise to
  negative externalities (eg. cigarettes) or
  sellers cant make a living (farming)

2
Minimum Prices

• Govt may intervene to raise agricultural prices
  and farm incomes
• Price cant go below the minimum
• Min price is always above the market price

Price
S
Min Price
Mkt Price
D
Qd
Qs
Quantity of Wheat
Excess supply
3
Minimum Prices

• While aims may be noble, outcomes can be dire
• Sellers have incentive to sell lots (they get a
  higher price now) buyers dont buy so much at
  the higher price
• Excess supply must be dealt with- destroyed
  (waste of resources)- dumped on less developed
  countries for rock-bottom prices (puts local
  producers out of business)

4
Maximum Prices

• Govt may fix a maximum price to ensure more
  people have access to the product
• Price cannot go above the maximum eg max rent on
  low-cost housing
• A maximum price is always below the market price

Rent
S
Mkt Rent
Max Rent
D
QS
QD
Quantity of flats
Shortage
5
Maximum Prices

• While the aims may be noble, the outcome may be
  worse!
• Shortages occur and even less is available to
  those who need it (sellers dont want to sell for
  such a low price not worth their while)
• Black markets may develop (with accompanying
  corruption illegal activity)

6
Unstable Commodity Prices

• Prices may fluctuate too greatly to achieve
  efficient allocation of resources
• Commodities are raw materials used in production
  of goods (eg. minerals, metals, or agricultural
  goods)
• Large swings in price distort messages sent to
  producers consumers, often resulting in
  under-production
• Makes it difficult for producers to earn a steady
  income, plan invest for the future

7
Agricultural Markets

• Although there is a long-term supply curve
  determined by all the different suppliers
  theoretical willingness to supply, actual supply
  in any given season is fixed perfectly
  inelastic
• Because demand for food tends to be relatively
  inelastic, a good harvest where prices fall,
  actually can mean falling revenue profits

8
Good Weather Good Harvest
S actual
S planned
Price
- Revenues tend to fall
P planned
P actual
D
Quantity of Wheat
Q planned
Q actual
9
Bad Weather Bad Harvest
S actual
S planned
Price
P actual
- Revenues tend to rise
P planned
D
Quantity of Wheat
Q actual
Q Planned
10
Price Income Elasticity

• Over the long run, supply of agricultural
  commodities has increased technology, GM foods,
  etc. decreased relative price of food
• But demand for food is price inelastic so
  revenues have fallen
• World incomes have risen, raising the cost of
  living and relative standard of living of
  production in the non-agricultural sector.
• But food is very income inelastic so farmers have
  not seen the benefits have fallen even further
  behind on relative terms

11
Time Lags

• The length of the growing season means there are
  time lags between farmers making decisions about
  production and actual changes in production
• This reduces the ability of producers to respond
  to changes in the market and find the best
  allocation of resources its a guessing game!

12
Buffer Stock Schemes

• Govt or relevant agencies establish a band
  outside which prices are not allowed to go
  authorities will step in to bring prices back
  into the band

S1
S2
Price
S
If prices rise above max, govt sells stock into
the market to bring the price down
Max Price
If prices fall below min, govt buys up stock to
bring price back up
Min Price
D
Quantity of Wheat
13
CAP (in a nutshell!)

• 1/3 of European Commission budget spent on CAP
• Subsidies min. prices cause food surpluses
  which have to be dealt with
• Selling them into foreign markets cheaply
  disrupts agricultural systems in other countries
• Destroying them represents a complete waste of
  resources
• Many countries object to CAP and it is criticised
  by the WTO