Price Floor and Price Ceiling Concepts Pros and Cons

Suppose dentist are given an incentives pay contract in which they are paid a fixed price per tooth extracted, per filling ,per crown, per routine inspection etc. where are the pros and cons of setting up such a scheme.

Price fixing is an undertaking between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand.

The intent of price fixing may be to push the price of a product as high as possible, leading to profits for all sellers but may also have the goal to fix, peg, discount, or stabilize prices. The defining characteristic of price fixing is any agreement regarding price, whether expressed or implied.

Neo-classical economists believed that price fixing is unproductive. The anti-competitive agreement by producers to fix prices above the market price transfers some of the consumer surplus to those producers and also results in a deadweight loss.

For this essay we would be looking at the pros and cons at price floor and price ceiling concepts on the scheme

Price ceiling

Price can’t rise above a certain level. This can reduce prices below the market equilibrium price. The advantage is that it may lead to lower prices for consumers.

Diagram Price ceiling

The disadvantage is that it will lead to lower supply. There will also be a shortage, demand will exceed supply; this leads to waiting lists and the emergence of black markets as people try to overcome the shortage of the good and pay well above market price.

For example,

1) During the second world war, price of goods was fixed and good rationed. However, this encouraged people to sell on the black market through inflated prices.

2) Tickets for football prices and concerts are often set at a maximum price. (e.g. if left to the market, equilibrium prices would be much higher). e.g. at current prices F.A. Cup final could sell many more tickets than 80,000.

The advantage of setting this maximum prices is that it keeps football affordable for the average football supporter. It is argue if prices were set solely by market forces, it would be just the wealthy who could afford to go to games.

The disadvantage is that it means some who want to go to the game can’t because there is a shortage of tickets.3. The government may set a maximum price for renting to keep housing affordable.

This may reduce supply of housing leading to homelessness.

However, it may be that landlords have monopoly power and supply is very inelastic. In this case a maximum price may make renting cheaper without reducing supply

Price floor

Price floor are used to give producers a higher income. They are used to increase the income of farmers producing goods.it is obvious in this situation that by incresaseing the price above equilibrum, governemt is assisting the producers and not the consumers.A higher price is going to mean a higher income for the producer. Which type of producer would the government help in this way and why? The answer is often farmers because farming has always been regarded as a special type of industry .Agriculture is different from other types of production for a number of reasons .Firstly; unlike say manufacturing ,supply cannot be totally controlled by farmers.the size of the harvest can fluntuate greatly from year to year and with it, the price and income of farmers.The second reason is that farmers produce a vey basic and important commodity that is food .Throughtout history ,countries have tried to ensure that they are totally dependant on others for food supply. If they were so dependent and if the supply were interupted because of war,civil unrest ,drought or other diasters then their postions would become precarious .finally government have often been reluctant to allow agricultural land to be traded freely in the marketplace .it is felt that this particular resource is very precious because it is used for other puposes, such as housing and other reasons ,government in most countries have tried to protect. And encourge their agricultural communties .And a way od doing it is throught price floor on agricultual products ,which would gurantee farmers a mimimum price.

For example, the EU had a Common Agricultural Policy (CAP). This increased the income of farmers by setting minimum prices.

Diagram Price floor

The Disadvantage of Price Floors

• Higher prices for consumers. We had to pay more for food
• Higher tariffs necessary on imports. The EU put tariffs on food to keep prices artificially high.
• May encourage oversupply and inefficient. The CAP encouraged farmers to produce food that no one actually wanted to eat.
• We had over-supply (butter mountains, wine lakes)

When the scheme is made the it enables both the buyer and seller to be able to do the following:

1) Predictability

A fixed-price contract gives both the buyer and seller a predictable scenario, offering stability for both during the length of the contract. A buyer may be concerned about the cost of a good or service suddenly increasing, adversely affecting his business plans. The seller may be concerned about the value of his good or service dropping suddenly, reducing his income with little to no warning. A buyer may also benefit from the predictability of a fixed-price contract, since any degree of uncertainty on the final cost of the project exceeding initial estimates shifts entirely to the seller. An employee of the buying company may favor a fixed-price contract because it gives him a concrete budget to present to his superiors for approval, versus a contract where costs may rise indefinitely over time.

2) Higher Charge

While a fixed-price contract gives a buyer more predictability about the future costs of the good or service negotiated in the agreement, this predictability may come with a price. The seller may realize the risk that he is taking by fixing a price and so will charge more than he would for a fluid price, or a price that he could discuss with the seller on a regular basis to account for the larger risk the seller is taking.

3) Market Changes:

When market forces change the value of a good or service, including any materials or supplies necessary in the production of the good or service, the fixed-price contract can be a benefit or a detriment. If market forces cause the value of the good or service to increase dramatically, the buyer receives a benefit while the seller loses potential profits he could have enjoyed outside of the fixed-price contract arrangement. When the price of the good or service drops suddenly, the buyer sits at a disadvantage and the seller at an advantage.

4) Budgeting and Ability to Pay

Even though a fixed-price contract may cost a buyer more money up front, the buyer has the ability to budget for the costs of the contract and ensure that it has enough funds to fulfill its end of the agreement. When the costs of the good or service increase dramatically, the buyer may no longer have the means to honor the contract, meaning the seller must take a loss and weigh the option of legal action. If the good or service is necessary to a buyer’s business process, then the buyer’s business may be adversely affected.

In conclusion 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 dentist prices

References

1) http://www.economicshelp.org/blog/621/economics/price-controls-advantages-and-disadvantages/

2) http://smallbusiness.chron.com/advantages-disadvantages-fixedprice-contract-21066.html

3) Louis Kaplow, On the Meaning of Horizontal Agreements in Competition Law , 99

4) Principles of micro-economics by john .E. Sayre and Alan J. Morris , page 88 to 90 chapter 3, fifth edition