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Updated on March 3, 2011

Free markets allow prices to be determined purely by the forces of supply and demand. Prices can be influenced by either changes in demand or supply or both. If the government wishes to influence the prices at which some product is bought or sold, it has two main alternatives. First, it could change the equilibrium price by altering the commodities demand and supply. Second it may change the price by enacting a law that regulates the price. Price control refers to the latter which is influencing price by law rather than market forces. The reason for price control may be any of the following.

Reasons for Price Controls

1. Price controls may be imposed to protect the interest of consumers, especially when prices of goods and services are extremely high, probably due to a reduction in output level, as a result of bad weather or natural disasters such as bush fires, floods earthquakes, or wartime shortages. In such cases consumers within the low income bracket cannot afford commodities. Governments come in here to ration the commodity among members of the society, by legislating maximum prices.

2. They may also be imposed with the view to protecting producers against fall in their incomes in order to ensure continuity in production. For instance a fall in farmers’ income due to an increase in output of agricultural products would most likely discourage production. To avoid such an occurrence, minimum prices are fixed, the aim of which is to guard against a fall in the farmers’ income and to encourage productivity.

3. Price controls may also be imposed to check inflation. Inflation occurs when there is a sustained upward trend in the general price level. During inflation periods those workers on fixed income suffer the most. Due to rise in the cost of living, savings level also falls. Price control is therefore one of the measures taken to solve inflation.

4. Labor may be paid a wage far less than the cost of living. Price controls allow the government to determine minimum wages that should be paid to workers. This is necessary because it will help the government to protect the interest of workers offering their services to exploitative employers.

5. It is possible that the free market forces of demand and supply may fail to distribute resources in the interest of the economy. Price controls may be used to distribute resources to the optimum in a society. For example market forces of demand and supply may direct labor to the distribution trade, as against acquisition of skills which is necessary for an efficient labor force. Government could redirect resources by offering higher wages to skilled labor.

There are two types of price control namely maximum price, also called price ceilings and minimum price (price floors). Maximum price is a price established by government beyond which it is illegal to sell. For all practical purposes, maximum prices are fixed below the equilibrium price. When fixed below the equilibrium price quantity demanded increases, because price has been reduced from a higher equilibrium. Suppliers however reduce the quantity they offer for sale thereby creating a shortage or excess demand oversupply.

Minimum price or price floors by definition is the price below which it is illegal for a commodity to be bought or sold. In most countries today, there are minimum wage laws specifying “floors” for the wages to be paid to different kinds of labor. Resale price maintenance, which exists in many countries, also gives the manufacturer power to prevent the retailer from selling below the prices that are set by the manufacturer. If the purpose of the minimum price is to protect the interest of the producer by increasing and stabilizing his income thereby encouraging the producer to produce more, then minimum prices must always be fixed above the equilibrium price. The equilibrium price is the price at which demand equals supply and has no tendency to change unless there is a change in either demand or supply or both.


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