The consequences of government imposing a price above or below the free market equilibrium Essay
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1. Use a diagram to show the consequences of government imposing a price above or below the free market equilibrium. (10)
When government imposes the free market and prohibits a price from going above a certain level, we call it price ceiling. If the price ceiling is below the equilibrium price, then shortages are created. The intention of price ceiling is to protect consumers from rapid price increases. However, this intention comes with consequences that are unintended. An example of price ceiling is the gasoline shortages in the 1970s.
The diagram below will show the consequences of price ceiling:
In the first stage (before government imposing), the equilibrium price of oil per gallons is $1.20. This is where the number of demand equals to the quantity of product sold. The graph of demand and supply when government imposes the price below the free market equilibrium is shown below:
We can see form the graph that the supply contracts from point A, the equilibrium, to point B, which represents the quantity of gallons if the price of oil was to be changed to .
When supply contracts, it means that the quantity of oil that is supplied becomes less. Because of the shortage of oil, the demand will extend. The lack of supply of oil and the excess demand, scarcity will occur. Even though scarcity of oil existed before, shortages did not happen before the government imposed.
Another outcome of price ceiling is the illegal economic activities that may occur. Because the maximum price that the government pointed is less than the equilibrium price, producers would feel that they could earn more money. With the shortage and the excess demand of oil, producers would then sell the products at a higher price illegally, and they would succeed in doing so because consumers would still need the oil that is so scarce in the market.
Because illegal economic activities would occur, the government would then need to hire inspectors. These inspectors would have to supervise the oil market. Hiring inspectors would cost the government more money; therefore the government spending will increase. However, the producers of oil that are investigated would still find a way around the rules and regulations from the inspectors. For example, the producers would lie about their income as they have sold their product in the black market to make more money. This would lead to tax evasion as well, because they would understate their own income.
2. Evaluate the impact of either rent controls or a minimum wage. (15)
Rent control is an example of price ceiling. This is a law that prohibits landlords to raise the price of rent to go above the price that they have determined. This law is determined by state or country legislatures. In Mumbai, the rent control act started in 1947, with the intentions of making houses affordable to more people. In rent control, the government imposes the price below the free market equilibrium, making the price lower than what it is supposed to be. Although the government intended well, the act proved that instead of benefitting the whole country, it mostly only benefit some of the poor and the people who already rented a place before the rent control.
In the short run, rent control helped many people in obtaining places to live. This mostly helped the poor people who could not afford rents before. However, the effects of rent control have not fully happened in the short run. The number of people who look for housing may not be as high as it takes time to arrange housing. As market conditions change, it also takes a long time until the landlords could adjust the number of apartments they rent. As a result, rent control in the short run had quite a positive impact.
However, as time passes, the disadvantages of rent control outweighed the advantages. Even though the intentions of rent control were to protect the rights of the poor, rent control did the exact opposite. As rent control continues in Mumbai, the landlords started to discontinue their rent because they are getting less money for their rents than the years before. Because the price of rents was below equilibrium price, landlords felt that they could earn much more with their rents. With the decreasing supply of rents in Mumbai, the number of demand increases. However, these demands could not be fulfilled with contracting supplies. As supply contracts and demand extends, the rent control act creates a shortage of rents. This would lead to homelessness, as people cannot find homes to live in.
Although the rent control act denied access to the migrants, it protected the people that are already housed in Mumbai. Because of their safety in the rent, the people that are housed would refuse to leave, and it would cause immobility, meaning that companies outside would not be able to hire someone from Mumbai, even though they are very capable for the job. There are also cases in which people give their houses to their children, their children give it to their children, and so on. This again, decreases the supply of rents. As time passes and the landlord wants to renew the houses, those people who have stayed in the houses would be paid to leave, thus becoming millionaires when they only had to pay $20 each month.
The lack of supply of rents is also seen as the biggest reason for slums in Mumbai. As the number of rents occupied increase and the number of the rents available decrease, more people would not have a place to live, resulting to the slums in Mumbai. Not only does rent control affect the tenants, it also effects what the landlords do. Because the price of rents fall, the landlords would not earn as much money as they did before, when it has potential to earn much more money. As a result, the landlords would decrease the quality of the houses. They could also charge the tenants for things that are supposed to be included in the rent expense, such as TV.
In conclusion, rent control acts, particularly in Mumbai had more disadvantages than advantages. Even though it protects the rights of the poor by decreasing the price below the equilibrium, rent control only lead to a shortage of rent. The shortages would then cause slums to increase, as the demand extends but could not be fulfilled.
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