What happens when government fixes maximum price (called control price) lower than equilibrium price?

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Write short notes on (i) control price, (ii) support price, (iii) Rationing, and (iv) Black marketing.

Control Price. When government fixes price of a product at a level lower than equilibrium price, the price is called control price (or price ceiling). Producers cannot sell their products above this price. It is the maximum price that can be charged for a commodity. This is done so that necessities become available to common people at affordable price. Since control price is lower than equilibrium price. It leads to excess demand and short supply. Suppose equilibrium price of sugar in a free market is र 30 per kg at which both demand and supply of sugar are equal, i.e., 60 tons. When government fixes price at र 20 per kg, demand for sugar rises to 80 tons and supply falls to 40 tons creating disequilibrium because supply falls short of demand as shown by the line AB in Fig.  The implication or consequence of price control can be any of the following:

(i)    Rationing. It is a system of distributing essential goods in limited quantities at control prices. This is done through Fair Price Shop. Rationing is resorted when due to shortage, a good is not available at reasonable price. Government establishes Public Distribution System (PDS) as a tool to help the consumers especially vulnerable sections of society through Fair Price Shops. A fair price shop is one which sells goods at control prices. Government may supply sugar (or any other commodity in shortage) at fixed price through Fair Price Shops so that a part of demand of all the buyers is satisfied.

(ii)    Black-Market. Another result of price control can be emergence of black-market in which the commodity, (here sugar) is sold at a price higher than the government fixed price (here र 10). The reason is that, on the one side, sellers are not ready to sell at a lower price fixed by the government and, on the other side, some consumers are ready to offer a higher price to satisfy their demand for sugar. In practice, it is difficult to prevent black-marketing when government controlled price is lower than the equilibrium price. A black-market is an illegal market in which goods are sold at prices higher than the price fixed by the government by law.

(iii)    Dual-marketing. To avoid the situation of black-market, government sometimes introduces a system of dual-marketing. It is a system of having two prices for the same commodity at the same time. Accordingly a certain quantity of the commodity (here sugar) is supplied to consumers at fixed price through Fair Price Shops and at the same time that commodity is made available in the open market at a price determined by free forces of demand and supply.

(b)    Support Price. When government fixes price of a product at a level higher than equilibrium price, it is called support price (or floor price). Floor means the lowest limit. It is the minimum price at which a commodity can be purchased. It leads to more supply and short demand. As a result supply becomes in excess of demand. Support price is generally fixed for agricultural products like foodgrains, sugar etc. to safeguard the interests of producers (farmers). This price is also called floor price because it is the minimum price fixed by the government. Suppose government fixes price of sugar at र 20 per kg. In that case demand is for 40 tons whereas supply at this price is 80 tons creating again disequilibrium or surplus of 40 (= 80 - 40) tons. This is shown as surplus in Fig. 4.17. In such a situation government may purchase large amount of excess supply of sugar (or any other product for that matter) at its fixed price (called support or procurement price) to protect the interest of producers like farmers. Support price is the minimum guaranteed price at which producers can sell their output to government if so desired. It is higher than equilibrium price. For instance, a government agency, Food Corporation of India purchases wheat from the farmers at its fixed (support) price and stores it in godown as buffer stock. The main consequence of support price is that consumers have to pay higher price for the good. Moreover, income of the farmers (producers) goes up. The aim of support price is to insulate farmers from the fluctuations in their incomes caused by price variations in the free market.

(c)    Minimum Wage Legislation. Like fixation of minimum price (i.e., support price) of an agricultural crop, government fixes minimum wage of labourers by law at a level higher than what the free market forces of demand and supply would determine it. The aim is to help the labourers and provide them social security since their bargaining power is quite weak. But experience shows that in real life, government implements minimum wage fixation in public (government) sector whereas due to lack of enforcement machinery, it is rarely implemented in private sector. Government should ensure that the employers pay to their employees the minimum wage fixed by the government.