GOVERNMENT PRICE CONTROLS

MINIMUM PRICES

A minimum price is a price floor set by the government where the price is not 

allowed to fall below this set level (although it is allowed to rise above it).

Reasons for setting a price floor:

•  To protect the earnings of producers – in certain industries prices are 

subject to great fluctuations.  Minimum prices will guarantee producers 

income in periods when prices would otherwise have been very low.  

Examples include certain agricultural products. 

•  To create a surplus – in periods of glut surpluses can be stored in 

preparation for possible future shortages.

•  To guarantee a certain level of earnings – workers can be given a 

minimum wage so that their earnings don’t fall below a certain 

(unacceptable) level.

The diagram below shows the effects of a minimum price: 

The minimum price has created a surplus (excess supply) of Qs – Qd.  There 

are three ways in which the government can deal with this surplus: 

The government purchases all the surplus to store it, destroy it or sell it in 

other markets.  If the government seeks to do this then it has to buy up the 

excess (Qs – Qd) at the current minimum price.  This means the cost to the 

government and therefore taxpayer is the shaded area QdabQs.

The government could artificially lower supply to Qd by issuing quotas which 

limit production. 

Demand could be raised by advertising, finding alternative uses or by taxing 

substitutes.

MAXIMUM PRICES

A maximum price is a price ceiling set by the government where the price is 

not allowed to rise above this set level (although it is allowed to fall below).

The reason for setting a maximum price is so that the prices of necessities 

don’t rise too much in times of shortage.  Such a situation is common in times 

of war and/or famine.

The maximum price has caused a shortage (excess demand) equal to Qd – 

Qs.  The government can deal with this in two ways:

•  First come first serve – this is the situation in a lot of eastern European 

countries and means that huge queues are common. 

•  Rationing – Purchases are limited by the number of coupons or 

vouchers issued.  Such as was seen during WWII.

•  Encouraging more homegrown production – as seen in WWII.

•  Drawing on stores from previous surpluses. 

Problems with maximum prices include:

•  Black markets – Selling of rationed goods illegally at very high prices to 

consumers who feel that they are not able to purchase enough legally. 

•  Reduces the supply of already scarce products.