Discuss whether the introduction of maximum prices by a government would solve the problem of scarcity.

Topics: Inflation, Macroeconomics, Keynesian economics Pages: 6 (1751 words) Published: February 22, 2014
Discuss whether the introduction of maximum prices by a government would solve the problem of scarcity. Introduction
Maximum price is the highest possible cost of a good or a service that is legally allowed. While an unregulated market usually does not have a maximum price besides what consumers are willing to pay, during certain times, the government would step in to assert some price control so that consumers within the country will not be affected that badly by inflation. (BusinessDictionary.com, 1999)

How Does Maximum Prices Affect A Country?
While setting a maximum price would ensure that all citizens of the country would be able to afford products, setting a price ceiling would shift the price equilibrium causing a few things to happen. Existing producers will realise that it is not profitable top continue operations in the market as there will be no competition for the pricing of products and thus exit the market. Also, prospective producers will not dare to enter the market due to fearing for their own losses. Lastly, current producers will only produce at the levels where the price ceiling is equal to the supply and will not increase supply to meet demand as there is no incentive to do so. Leaving the problem of scarcity in the country to escalate further and not be of help to the country even if the government set maximum prices.

Shortage of Supply?
When the ceiling is set below the market price, there will be excess demand or a supply shortage. Producers will not produce as much at a lower price, while consumers will demand more because the goods are cheaper. Soon, demand will outstrip supply, in which there will be a lot of people who want to buy at the lower price but cannot. Still, if the demand curve is relatively elastic, then the net effect to consumer surplus will be positive. Producers are truly harmed as their surplus is doubly hit with a reduction in the number of firms willing to take that lower price, and those who remain the market have to take a lower price.

The resulting shortage of goods can lead to consumers having to queue up in line to get the goods, government rationing, and even the development of a black market dealing with the scarce goods. (EconPort, 2006)

A very good example would be of the house-rent market.
Here in the graph above, a price of pE has been determined as the equilibrium price with the quantity at QE homes. Now, the government determines a price ceiling of pC. At this rate there is a shortage as demand is for QD, but supply is for only QS houses at the price ceiling. In the long run, the extra people will try to get a house on rent, which will eventually give rise to black market and higher rents. (The Economic Times, n.d.)

What Happens When Price Ceiling Is Removed?
Furthermore, once such controls are removed, prices will immediately increase sharply in an attempt to balance out and create market equilibrium, which would then temporarily shock the economic system. (Wessels, 2006)

In conclusion, the introduction of maximum prices by a government would only increase the problem of scarcity, as well as allowing the black market in the country to flourish.

Question 2
Explain the key macro-economic aims of the Singapore government, and discuss which policy measures might best be used to overcome the most significant macro-economic problem that is currently being experienced by the Singapore economy. [10 marks] Introduction

Singapore's economic achievement is due to a set of sound macroeconomic policies aimed at maintaining a conducive environment for long-term investment in the economy. Fiscal policy is directed primarily at promoting long-term economic growth, rather than cyclical changes or distributing income. As a result of its healthy fiscal position and consistent budget surpluses over the years, Singapore has attained a high level of foreign reserves and the strongest sovereign credit rating for long-term foreign-currency...

References: Anon., 2013. Monetary Policy Operations in Singapore. [Online]
Available at: http://www.sgs.gov.sg/~/media/2013-03-13%20Monetary%20Policy%20Operations%20Monograph.pdf
BusinessDictionary.com, 1999. What is Maximum Price. [Online]
Available at: http://www.businessdictionary.com/definition/maximum-price.html
EconPort, 2006. Price Floors and Ceilings. [Online]
Available at: http://www.econport.org/content/handbook/Equilibrium/Price-Controls.html
Monetary Authority of Singapore, 2013. The Singapore Economy. [Online]
Available at: http://www.sgs.gov.sg/en/The-SGS-Market/The-Singapore-Economy.aspx
Singapore Government Securities, 2013. Fiscal Policy. [Online]
Available at: http://www.sgs.gov.sg/The-SGS-Market/Fiscal-Policy.aspx
Wessels, W. J., 2006. Scarcity. In: Economics. 4th ed. London: Barron 's Educational Series, pp. 232-233.
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