Consumers and producers sometimes lobby the government to set a market price different from the equilibrium. This lobbying is facilitated by consumer watch groups and manufacturer associations in the country. Though society benefits more in a competitive market environment, customers love to pay a price lower than the equilibrium, and producers would love to sell their products at a price higher than the equilibrium price. For instance, during the Great Depression in the 1930’s government of the United States introduced price floors in response to farmers’ plea to sell their products only at low prices. That move by farmers’ is one of the many reasons why authorities intervene through price control and market regulation mechanisms. Price floors entice producers to produce more output than the market demands. The surplus created by the price floor is stored by the government to help in national planning.
The most notable intervention of government is through tax collection from both consumers and producers. Most governments in the world have introduced what is often refered to as sin tax. This is tax levied cigarettes and alcoholic beverages so as to control public consuption of harmful substances on one hand while they over-tax it on the other hand to meet revenue targets.
Consumer surplus, producer surplus and economic surplus
For us to appreciate the effect of government price controls and taxes on economic efficiency, it is important to understand consumer surplus, producer surplus and economic surplus.Consumer surplus refers to the difference between the maximum price a consumer is ready and able to pay and the one he actually pays. It is a measure of the dollar benefit consumers get from buying goods and services from a certain market. Producer surplus refers to the difference between the lowest price a firm is willing to accept and the one it actually accepts. A firm will produce an extra unit only and only if they get a price equal to the extra cost of producing that unit. Economic surplus is best described as the sum of consumer surplus and producer surplus. This offers the best way of measuring how society benefits from best practises of production of a product. A dead weight loss is the reduction in economic surplus when a market is out of competitive equilibrium.
Economic efficiency: when the marginal benefit to consumers of the last unit produced is same as its marginal cost of production in a market, and where the sum of consumer and producer surplus is at a maximum, then economic efficiency is said to have been achieved.
Government policy: Price ceilings and Price floors
Governments influence market outcome by imposing price ceiling or floors. A price ceiling implies the maximum price that businesses may be charged for a product as a result of external influences. As such a price ceiling limits the price that a good reaches its market equilibrium price. When the ceiling price is below the equilibrium its effect self- evident in the form of :
1. Low quantity supplied
2. High demand in the market
This will create a shortage since the quantity demanded is less than the quantity supplied. Such a product should be rationed by price otherwise it will end up in the black market. A black market refers to buying and selling of goods and services at prices that violate government price regulations. Examples can found in gas prices and caps on consultancy fees.
In over 200 cities in the United States, government has placed ceilings on the maximum rent the landlords can charge for their apartments. Price ceilings are found mostly in markets of apartments of various cities. It is estimated that in New York City, over one million apartments are subject to rental control. The impact of a price ceiling on rent is that the quantity asked at the ceiling price, for istance $800 per month, is greater than the quantity supplied. Contrary when an equilibrium price of about $1600 were allowed, the quantity supplied would be higher than the quantity supplied.
Price ceilings has different effects that include the following: Transferring some producer surplus to consumer surplus and creating a deadweight loss of producer and consumer surplus. On the other hand, price floors imply the minimum prices that raise the equilibrium price of products above the free market point.
The impact of a price floor is two fold. It transfers some consumer surplus that would exist at the equilibrium price to consumer surplus and two, it creates a deadweight loss. The deadweight loss can also be defined as the efficiency loss that results in the price floor.
A good example of price controls is the minimum wage law. Minimum wage is the legal wage imposed above the equilibrium wage. According to statistics most workers earn wages above the minimum wage therefore the price floor (wage) affects low skilled and inexperienced workers. Economic impact of minimum wage may be similar to that of price floors in other markets, but economists have disagreed the extent to which minimum wage reduces unemployment.
Authorities world over impose taxes over goods and services and by so doing affect in many ways, laws of supply and demand. When taxation goes up the production cost of a good/service goes up. The producer has no option other than to pas on the cost to the consumer. Most consumers buy goods on price therefore, high taxation will leave most consumershard pressed for disposable income hence less demand. Governments generate most of their income from taxing their subjects. Market equilibrium of a good is affected when government taxes that good. Every citizen in every country pays taxes, but what is the effect of taxes on equilibrium prices? Many factors contribute to the taxation isssue. In a competitive market it shouldn’t matter on whom the tax is being levied on , that is consumer or producer. If the consumer can forgo the product being taxed demand will be elastic and the producer will pay more tax. When the consumer has to buy the product anyway, the demand will be inelastic and the consumer will pay the bulk of the tax. Simply put the producer pays more when demand is more elastic than supply; while the consumer will pay more when the demand is less elastic than the supply.
Reduction in economic efficiency
Benefits and that may affect someone not directly involved in the manufacture of a good or a service is called an externality. Negative externalities are costs accrued on non-cosenting persons. Positive externalies are the rewards for persons not directly involved in manufacturing or purchasing a good or a service. Seen as they cause a difference between private cost of production,externalies may tamper with the economic efficiency of market dynamics. The social cost refers the private cost plus any external cost emanating from manufacturing; the social benefit is the private benefit in addition to any external benefit that results from the use of goods and service.
In a situation where there is a negative externality due to production, the market supply curve understates the true production cost. On the left of the market supply curve should be a suppply curve that resembles social costs. To minimise contamination,pollution, institutions and governments are ising a new approach. This approach requires governments to impose quantitative limits on amounts of pollution big industries can emit or the installation of specific pollution control devices. In the Clean Air Act voted by Congress in 1990, a reduction in sulphur dioxide emissions, a great cause of acid rain, from electric utilities and devices was made mandatory. To realise this goal, utilities were allowed to trade in emissions allowances. Each allowance is equated to one tonne of sulfur dioxide. Provided the total amount of emissions is less than an annual mandated maximum amount , firms can emit sulfur dioxide in amounts corresponding to their allowances.
There is a trade-off for firms between high cost of minimising sulphur dioxide and incentives for buying more allowances granted. Companies that can minimise their gas dischrage at low cost have a go-head to do so and sell part of theirallowances. Since 1990 this program has beaten expectation by achieving emission reduction at much low cost than earlier forecasted. The sulphur dioxide emission program's success has led industry players to suggest that a program of the same kind be used by the Great nations so as minimise emissions of “greenhouse gases” that lead to global warming.
Taxation results in decline in economic efficiency. Price controls and taxation are necessary protect consumers and producers from exploitation while on the flip side ensuring a free market economy. Price controls have regulate prices of necessities like food and fuel , however the business community has always been against price control arguing that they lead to over-regulation. In a competitive market, equilibrium leads to an economically efficient results level where marginal cost equals to marginal benefits.