For instance, if the bread price goes up – (weather fluctuation and poor harvest of wheat-) the supply curve will shift to the left (S’-Q1P1). The change in the price of bread will cause change in another good in another market.
It can be a complimentary good, butter. They relationship is inverse, so the reaction is opposite with the other. People will buy less butter because they consume them together (D’-Q2P2) and the price of butter will decrease.
If there is a substitute relationship between two goods -butter and margarine- one good attract on another. If customers buy less butter, they also consume less from margarine, so the curve of demand will shift. People will buy Q1 quantity of margarine at P1 price.
(The prices/quantities are not the same volume on the graphs)
The function of price
The price system has three functions which gives benefit both the producer and the consumers.
Information:
The price must transmit information to the members within the market.
If the demand increases in a market, people want to buy more. The shopkeepers will order more from the firms. They might increase the price. For instance, it is possible that they have to employ more workforces or pay them more. All people will be aware of the change of prices who is involved in the market.
Incentives:
The price system must provide incentives for people to act in a certain way.
Good example, when the price is rising. The firms will produce more because they can increase their profit and use more work forces.
Income distribution:
The price system must to attempt to influence the income distribution.
For instance, employees wages depend on his success in his employer’s business and the demand and supply of people with their skill. If there is a shortage for a particular job, companies will pay more who can carry out this work.
People who got skill that relatively too many people have, he will receive low earnings.
(b)
In the theory of economics, the supply and demand system perfectly and automatically works in the free market and always an “invisible hand” helps to lead it to the equilibrium. So why the government still seeks to control prices at a level?
Direct price control
Sometimes the “invisible hand” just needs some help to get the market into the equilibrium for some reasons and the government directly has/wants to control prices.
Minimum price (price floor)
When the government sets the price on a minimum level and it is not allowed to fall below this, then we are talking about minimum price.
One of the aims can be the legislation of minimum wages to protect the law of workers so the firms can not exploit them. (Introduced in 1894 in New-Zealand). The minimum wage level have to be higher than it is normally set by the market, otherwise it make no sense to introduce it. In most of developed countries this system works but this strategy can easily cause bigger damage than benefit if the labour market is in equilibrium1.
Secondly, it is also good for the companies. For example, the minimum wages reduce employee-initiated quits. Mixon (1978) 2
Another reason can be if it is supposed that there was a fluctuation in the weather, the crops yield could fell dramatically and the producers’ income would fell too. The minimum price strategy helped the companies to get to the appropriate money. If the opposition happened of that then the government might have striven to create a surplus for the shortage in the future or to sell it abroad in the other markets.
For instance, in the USA the 2002 Farm Bill a “milk income loss contract” (MILK) tend to protect the farmers. New England Dairy Compact (between 1997 and 2002) created a price floor for New England dairy farmers to reduce downside variance of prices risk and keep more New England farmers in the industry.
The problem with the minimum price is that the companies might try to sell their surplus products illegally somewhere else in the market.
Maximum price (ceiling price)
Maximum prices are designed to prevent prices rising above a certain level.
The government with this strategy tries to protect the poorer.
Office of Price Administration (OPA), U.S.A during the Second World War used maximum price strategy. Almost 90% of the retail food prices were frozen and the aim was to keep down the prices of goods on a low level (particularly the basic goods such as: bread, butter, sugar, meats etc.) so the poor people could afford to buy them too. The other very important reason is, to prevent inflation in wartime.
In other special case when there is no wartime or fluctuation but the government still seeks to set the price on a certain amount. There was an interesting situation between the United State (Anti-trust Division) vs. Microsoft software company in 1998. Because of the enterprise has monopoly in the industry, Microsoft had been ordered that it had to charge the same price for its product(s) for the first twenty computer manufactures.
If the allocation system is set wrong, the consequence of low fixed prices might lead to black market.
Price band
Price band is when government sets the good’s price or rate’s value between a maximum and a minimum level and it has to be stay between the two levels.
This method used in managing stock index rate, exchange rate or primary goods.
Primary good is like oil. For instance, OPEC did intervention four-year ago and it identified US$ 22 to US$ 28 per barrel as the price range that balances the interests of consumers and producers. It supported price stability therefore it encouraged investments in the industry.
Indirect price control
Tariffs
The regulator intercedes with higher prices for its domestic market.
Firstly, tariffs are raising the prices of goods and reducing demand. It is good for the government because it helps to protect its residents from the harmful goods. Typical example the EU tobacco policy restricts produced quantities to fixed quotas and therefore people demand less for higher prices.
Sometimes government wants to protect its domestic industry from international competition and the tariff on imported products tend to decrease its demand. EU sets barriers against countries outside of EU to protect the domestic market (especially agricultural products). Inside the EU countries do not have to pay tariffs between each other but out of EU countries have to pay tariffs if they want to sell their products in the market.
Inverse provision of tariff can be used when a country has monopoly power in their supply and called export tax increases the prices.
If the government does not want to burden its voters with big taxation, it is good way to raise its own revenue with tariffs.
Sometimes accomplished government can obtain greater popularity before the election. If they play with the numbers and reduce the rate of direct tax but increases the rate of indirect tax thus it seems to be prices went down.
In 1993, Bill Clinton American president proposed energy tax because among others he wanted to cut back the USA’s deficit with the extra revenue from the oil tariff.
References:
- Brinley Davies, Geoff Hale, Charles Smith, Henry Tiller 1996, Investigating Economics,
London, Macmillan Press LTD
- Brian Attkinson 1995 Economics in the news, Cornwall, Addison-Wesley Publishers Ltd.
- David Roberts, Maggie Grant, Alan Dobson, Ray Bentley 2000, British Politics (2nd edition), Causeway Press
- John Sloman, 2001 Essential of Economics, (2nd edition), Harlow, CWS
- Michael Parkin, Melanie Powell, Kent Matthews 2000, Economics (4th edition), Addison- Wesley
- Stephen Ison 1996 Economics, (2nd edition), London, M&E Pitman Publishing
- Madrid Athens Paris 1995 Core economics, Avon, The Bath Press
American Journal of Agricultural Economics, August 2004 v86 i3 p594(11)
Entry, exit, and farm size: assessing an experiment in dairy price policy. Jeremy D. Foltz.
COPYRIGHT 2004 American Agricultural Economics Association
Hydrocarbon Processing, Feb 1993 v72 n2 p15(1)
Who benefits from an oil imports tax? (Bill Clinton's energy tax proposal) (Editorial) Charles H. Vervalin.
COPYRIGHT Gulf Publishing Company 1993
Harvard International Review, Fall 2003 v25 i3 p24(5)
Changing the mix: renewable energy and the continuing need for fossil fuels. (Perspectives) Alvaro Silva Calderon.
COPYRIGHT 2003 Harvard International Relations Council, Inc.
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