Impact of government regulation on managerial
Decision making
Impact of government regulation on managerial
Decision making
how methods of control can influence market prices.
Price Controls
In a free market mechanism, price is set by the demand and supply intersection. In the short run, price changes will eliminate shortages or surpluses. In the long run, resources shift from the production of one product to another in response to changes in demand. The shift away from one equilibrium and the move to a new equilibrium will proceed when these movements are permitted to occur freely and are not impeded by any outside interference. For instance, when the supply of wheat decreases and prices rise, the market clears this new price - that is, at the new intersection of supply and demand.
Price Ceiling
However, in present economic institutions, free movement of price is not always allowed. In many instances, government has to intervene to set prices of various products to protect the interests of consumers and producers. Price ceiling is set by government on various products. That is, these products cannot be sold at prices higher than prescribed by the government. If the price ceiling is set below the equilibrium price, then a shortage will occur. P is the equilibrium price in Fig. 10.1 at which Q quantity is sold. Suppose the price is set at P1 under free market conditions (i.e., no price controls), the price will rise until equilibrium price is reached.
But if the price ceiling is not higher than P1'' then the movement towards equilibrium will not take place. Only Q1 will be supplied while Q2 is demanded at a lower price, so that a shortage of magnitude Q1 - Q2 will be established. Thus, consumers between O– Q1 will be able to buy a particular product. Due to this forced disequilibrium, consumers will try to shift their demand to other products, causing a pressure on prices of other products.
There is another possible result. Since only Q1 units are sold at price P1, these units could be purchased at price P2 along the demand curve. Consumers would be willing to pay P2, a price higher than the equilibrium price P, for the limited quantity Q1'' Thus, a strong pressure on the price is exerted and the difference between P1 and P2 will be paid to the suppliers.
In World War II, a ceiling price on automobiles that would have cleared the market was imposed on new cars. This low price caused automobile manufacturers to limit their production. However, consumers were paying a high price for the cars in way of dealer''s premium. They may also have received lower trade-in prices on their old automobiles or may have bought their new car as a "used" one, since second¬hand cars were not price-controlled. The price they actually paid was indeed higher than it could have been if the manufacturers had charged a higher list price. Similarly where a rent ceiling is imposed, many people end up paying a bonus to the rental agent.
Price Floors
Under price floor policy, price is set below the level at which the product or service may not be sold. Legal minimum wage is such an example. Employers are not allowed• to pay their workers less than the established minimum, and must, therefore, deal with price disequilibrium. Suppose the equilibrium wage (e.g., per hour) for some unskilled work is W, as shown in Fig. 10. 2, but the law stated that a ''wage lower than W1 is illegal, then a surplus of labour Q1 - Q2 would exist. In the absence of minimum wage law, wages would fall to W, and quantity supplied and demanded of labour would meet at Q. Thus, all workers offering themselves for employment at that wage would be hired.
Most economists agree that minimum wages above equilibrium level tend to cause unemployment among least skilled labour. The worker in the labour market who are retained after the imposition of legal minimum, will be better off than they were before. These workers can be found in the interval of O - Q1. The short run effects of an increased legal minimum are probably stronger than the long run effects. As time passes, the wage levels in the economy will rise (either due to inflation or in real terms), and at some point the minimum wage may approach the free market equilibrium wage.