Effect of Price Floor and Ceiling on Agriculture and Petroleum Industry Submitted by: Imran Abdul Qadir (SP12-EX- 0060) Shoaib Ahmed (SP 12-EX-0085) Imtiaz Sheikha (SP11-EX- 0005) Muhammad Talha (SP11-EX- 0004) Submitted To: Mr. Shujaat Mubarak
Oct 24, 2015
Effect of Price Floor and Ceiling on Agriculture and Petroleum Industry
Submitted by:Imran Abdul Qadir (SP12-EX-0060)Shoaib Ahmed (SP 12-EX-0085)Imtiaz Sheikha (SP11-EX-0005)Muhammad Talha (SP11-EX-0004)Faisal Ashraf Ali (SP11-EX-0010)
Submitted To:Mr. Shujaat Mubarak
INTRODUCTION
In this presentation, we have highlighted the effect of price flooring and price ceiling on agriculture and petroleum sector. That whats effects occur on industry. This presentation consist bit introduction of price flooring and ceiling, then some related application alongwith effects indications.
These are usually enacted when policymakers believe the market price is unfair to buyers or sellers.
The government can enact Price ceilings, and Price floors.
Price Ceiling and Price Flooring
Price ceilings that involve a maximum price below the market price create five important effects on industry.1. Shortages2. Reduction in Product Quality3. Wasteful Lines and Other Costs of Search4. Loss of Gains from Trade5. Misallocation of Resources
(a) A Price Ceiling That Is Not Binding
Quantity0
Price
Equilibriumquantity
40 Priceceiling
Equilibriumprice
Demand
Supply
33
100
Price Ceilings Create Shortages
Quantity
PriceSupply
Demand
Market Equilibrium
ShortageControlled Price (Ceiling)
Qsupplied at the Controlled Price
Qdemanded at the Controlled Price
1. When prices are held below the market price shortages are created.
The shortage The shortage = difference between the Qd and the Qs at the controlled price.
The lower the controlled price relative to the market equilibrium price, the larger the shortage.
(a) The Price Ceiling on product Is Not Binding
0
Price
1.When,the priceceilingis notbinding . . . Price ceiling
Demand
Supply, S1
P1
Q1 Qty
(b) The Price Ceiling Is Binding
Quantity0
Price
Demand
S1
S2
Price ceiling
QS
4. . . . resultingin ashortage.
3. . . . the priceceiling becomesbinding . . .
2. . . . but whensupply falls . . .
P2
QD
P1
Q1
2. At the controlled price, sellers have more customers than goods. In a free market, this would be an opportunity to
profit by raising prices. But when prices are controlled, sellers cannot. Sellers respond to this problem in two ways:
Reduce quality Reduce service
Price Ceilings Create Wasteful Lines
Quantity
Price
Supply
Demand
Market Equilibrium
Controlled Price (Ceiling)
Qsupplied at the Controlled Price
Total Value of Wasted Time
Shortage
Willingness to Pay
Tim
e C
ost
3. Price controls that create shortages lead to bribery and wasteful lines. Shortages: not all buyers will be able to
purchase the good. Normally, buyers would compete with
each other by offering a higher price. If price is not allowed to rise, buyers must
compete in other ways.
Industry will not supply the best and result will be:
How I Can Supply you Petrol at low Profit margin.
Dead-weight LossDead-weight Loss is the total of lost consumer and producer surplus when all mutually profitable gains from trade are not exploited.
Price ceilings create a dead-weight loss by forcing Qs below the market Q.
Buyers and sellers would both benefit from trade at a higher price, but cannot since it is illegal for price to rise.
4. Price controls reduce the gains from trade. Price ceilings set below the market price cause Qs to be
less than the market Q. When Q is below the equilibrium market Q, consumers
value the good more than the cost of its production. This represents a gain from trade that would be
exploited (if the market were free).
Qmarket
Market Price
Controlled Price (Ceiling)
Qsupplied Qdemanded
Willingness to Pay
Consumer Surplus Shrinks to this
Shortage
Consumer surplus in market equilibrium
Price Ceilings Reduce the Gains from Trade
Quantity
Price
Supply
Demand
Market Equilibrium
Producer Surplus Shrinks to this
Producer Surplus in equilibrium
Qmarket
Market Price
Controlled Price (Ceiling)
Qsupplied Qdemanded
Willingness to Pay
Deadweight Loss (lost gains from trade)= Lost Consumer Surplus+ Lost Producer Surplus
Shortage
Lost Consumer Surplus
Lost Producer Surplus
Supply
Demand
Market Equilibrium
Total Value of Wasted Time
5. Price controls distort signals and eliminate incentives-- leading to a misallocation of resources. Consumers who value a good most are prevented
from signaling their preference (by offering sellers a higher price.)
So producers have no incentive to supply the good to the “right” people first.
As a result, goods are misallocated.
Price floorPrice floor: : a minimum price allowed by law. not as common as price ceilings (but still important)
Price floors have four common effects:1. Surpluses2. Lost gains from trade (deadweight loss)3. Wasteful increases in quality4. A misallocation of resources
(a) A Price Floor That Is Not Binding
Quantity0
Price
Equilibriumquantity
20
Pricefloor
Equilibriumprice
Demand
Supply
33
100
21
If the government sets a price floor for butter above the equilibrium market price, what will be the effect?a)Farmers will produce less butter and consumers will purchase more, resulting in a shortage of butter.b)The supply of butter will increase and the demand will decrease.c)Farmers will produce more butter and consumers will purchase less, resulting in a surplus of butter.d)The equilibrium price will rise to the price floor.
(b) A Price Floor That Is Binding
Quantity0
Price
Demand
Supply
40Pricefloor
80
Quantitydemanded
120
Quantitysupplied
Equilibriumprice
Surplus
33
A binding price floor causes . . . a surplus, because quantity supplied is greater than
quantity demanded. non-price rationing, which is an alternative
mechanism for rationing the good, using discrimination criteria.
Examples: The minimum wage, agricultural support price and Royalties.
Quantity
Rate
0
Supply
Surplus of stock
demand
MinimumWage
Quantitydemanded
Quantitysupplied
Consequences:1.Demand falls between 1 and 3 percent for every 10% increase in the minimum wage / support price2.The total income of consumer rises•Some consumer change their requirement•Opportunities for sale are reduced•A lot of them are from middle-class families
Price controls that create surpluses lead to wasteful increases in quality.
If they can’t lower price, sellers will find other ways to compete!
Willingness to Sell
Controlled Price (Floor)
Qdemanded at the Controlled Price
Quantity
Price Supply
Demand
Deadweight Loss
Market Equilibrium“Quality” Waste
The equilibrium quantity increases The price paid by buyers falls
So, buyers gain The price received by sellers increases
So, sellers gain too The total gain = the total subsidy Which side gains how much depends on the price
elasticities of demand and supply
27
Higher quality raises costs and reduces seller profit. Buyers get higher quality, but would prefer a lower price. Price floors encourage sellers to waste resources: higher quality than buyers are willing to pay for