Price Controls Definition

Usually, the government imposes such techniques as a short-term measure to ensure the affordability of essential products and services to the public, fight inflation and deflationInflation And DeflationInflation means an increase in the prices of general goods and services. Deflation, on the other hand, represents the decrease in the prices of goods and services. Together they play an integral part in determining and maintaining the stability of an economy.read more, etc. It, in turn, maintains the consumers’ purchasing power and economic growthEconomic GrowthEconomic growth refers to an increase in the aggregated production and market value of economic commodities and services in an economy over a specific period.read more. However, in the long run, the control measures seem ineffective.

Key Takeaways

  • Price controls refer to the deliberate action of setting maximum or minimum prices for specified goods and services by the government.

  • They are generally classified into two types – price ceiling and price floors. Price ceiling refers to the maximum price, and price floors indicate the minimum price chargeable for the specific goods and services.

  • It is used to fight inflation, deflation, consumer exploitation, etc.

  • “Nixon shock” is one of the examples of a government imposing price restriction strategies to fight inflation.

Price Controls in Economics Explained

Price controls are an example of economic interventionism by the government using economic policies to interrupt market forces. For example, the government may raise or reduce the standard prices of products and services, disregarding the equilibrium prices. However, it will help the government in different ways, like to attain price stability and steer clear of inflation and deflationDeflationDeflation is defined as an economic condition whereby the prices of goods and services go down constantly with the inflation rate turning negative. The situation generally emerges from the contraction of the money supply in the economy.read more.

It’s an important tool to many economies, like how they use interest rates, open market operationsOpen Market OperationsAn Open Market Operation or OMO is merely an activity performed by the central bank to either give or take liquidity to a financial institution. The aim of OMO is to strengthen the liquidity status of the commercial banks and also to take surplus liquidity from them.read more, and reserve requirementsReserve RequirementsReserve Requirement is the minimum liquid cash amount in a proportion of its total deposit that is required to be kept either in the bank or deposited in the central bank, in such a way that the bank cannot access it for any business or economic activity.read more to influence movements in the economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more. Also, this type of control measure helps the government to curtail the negative impacts of their policies. For example, lowering interest rates pave the way for inflation, and in such a situation, the government can impose price control measures to stop inflation.

The Nixon Shock exemplifies using price restrictions as a key method against inflation. It is the name given to a set of economic policies undertaken in the United States by President Richard Nixon in 1971 to curb inflation and wage escalations. The president announced that all prices and wages in the United States would not change for three months. Nixon’s pricing controls were effective for a time. However, Nixon’s price controls phase II imposed highly complicated requirements, which were disliked by the public.

Example

Let’s consider the measures adopted by China recently to present price controls example. China’s price controlling efforts are not confined to a few industries. It includes measures covering different sectors like power and agriculture. All these intended policy changes point to the scaling up of control measures in the economy.

One of the measures includes China’s plan to deal with the abnormal fluctuations by adopting policies to fix iron ore, copper, corn, and other major commodities prices. Therefore, it will reflect the 14th five-year plan for 2021 to 2025. In addition, China will also focus on the pricing of commodities like crude oil, soybean, etc., reasonably adjusting cotton target price levels and checking whether entities are following the country’s minimum purchase price policy framework for rice and wheat. Hence building a solid grain supply and stabilizing prices to guarantee food security in the nation.

Types of Price Controls

The government sets prices to ensure that specific goods and services are sold fairly to every citizen. Price controls on goods can be set by two types: price ceiling and price floor. It forms a bracket where one is the maximum price and the other is the minimum price. The producers and sellers must ensure that they cannot go further or below that.

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#1 – Price Ceiling

Price ceiling refers to the maximum price authorized by the government for certain goods and services, letting the seller charge. A price ceiling scenario is common in regions where the demand for goods and services is high and the supply low. As a result, the maximum price decided by the government is usually a price lower than the equilibrium price.

#2 – Price Floors

Contrary to a price ceiling, a price floor refers to the government setting the minimum legal price of certain goods and services. If the price floor is set, a buyer will not be able to buy the product at a price below the price floor in a standard setting. It ensures the protection of producers from scenarios entailing features like low demand, excess supply, under-pricing or below-cost pricing, etc. 

Pros and Cons

The controlling measures often entail positive and negative impacts. Let’s look into some of them.

Pros:

  • Consumers’ interest: The price ceiling ensures the affordability of consumer products, specifically consumer staples. For example, setting an upper limit for maximum rent chargeable eliminates the exploitation of tenants or rentee by landlords.Producers’ interest: The price floor protects many sectors from suffering losses due to low prices due to excess supply or low demand. For example, this strategy protects people like farmers and protects their right to receive the rightful compensation. Fair competition: Encourage sellers to participate since the policies reduce price manipulations actively. Hence it enhances healthy competition.Fight inflation: It reduces the inflation rate.Fight deflation: It decreases the deflation phenomenon and protects the economy from depression. For example, when the U.S. government adopted price control measures during World War I and II, it helped them revive in the period of the great depressionGreat DepressionThe Great Depression refers to the long-standing financial crisis in the history of the modern world. It began in the United States on October 29, 1929, with the Wall Street Crash and lasted till 1939.read more.Stop monopolies: Restrict the formation of monopoliesMonopoliesMonopoly is the “one-&-only” seller of a good or service in the market & it faces no competition from any other entity. Generally, it is controlled or monitored by the Government to safeguard the customers’ interests. read more.

Cons:

  • Shortages and excess demand: If the government set price ceiling is below the equilibrium price, the chance of an increase in demand is high; hence it will lead to a scenario of excess demand or inadequate supply. Inadequate supply can lead to rationing and the generation of parallel markets.Excessive supply and lesser demand: In most cases price floor for a product is greater than its equilibrium price formed by supply and demandSupply And DemandSupply has a direct relationship with the price. Thus, if the price rises, the product’s supply will also increase, and if the price falls, then supply will also decrease. In contrast, demand has an indirect relationship with price. Thus, if the price drops, demand will rise and vice-versa.read more forces. Hence it automatically leads to a situation of excess supply and low demand.

This has been a Guide to What is Price Control in Economics & its Definition. We explain price controls on goods, examples, Nixon shock, types, pros & cons. You can learn more from the following articles – 

Price controls are defined as the economic tool used by the government to restrict price changes of certain products and services. The government sets the minimum or maximum price of products and services directly in a free market. They establish the maximum price (price ceiling) and minimum price (price floor) to ensure that consumers can afford these basic essential items in any market conditions hence regulating phenomena like inflation and deflation.

The two types are price ceiling and price floor. A price ceiling is a maximum price that can be charged for a product or service by the seller. At the same time, the price floor is the minimum price that goes to the producers or sellers from consumers for purchasing products or services from them.

The objectives may vary with the circumstances in which it is used. Generally, it aims to control inflation or deflation, protect consumers from exploitation by sellers, etc.

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