Government Intervention In The Market Place

GOVERNMENT INTERVENTION IN THE MARKET PLACE

ECONOMICS 101 ESSAY 2

28TH APRIL 2006

ABSTRACT

The government may choose to set prices different to those set by the markets. Prices are not allowed to drop below a certain minimum. For example, in Agriculture, government may choose to subsidies farmers, set production quotas or offer price supports. Government may decide to set price ceilings or price floors. The government may also choose to increase or decrease taxes on certain commodities. In this essay, we will look at the effects of government intervention from an economic perspective.

According to the Financial Mail (2006) In February this year, inflation rate in Zimbabwe reached the highest level in the world - an annual 782%. It is estimated that by the end of this month, Zimbabwe's year-to-year inflation rate will have topped 1 000% this is according to calculations by the regionally represented Imara financial-services group (Mail and Guardian, 2006). As inflation increases to ridiculous rates, the Zimbabwean government is forced to offer some sort of relief for its people. Prices of basic commodities such as food and fuel are rising sharply on an almost day to day occasion while wages have remained fairly the same (Financial mail, 2006). Due to public or rather social concerns, the government has been forced to set price controls for basic commodities such as food, fuel and transport costs.

"A price ceiling is a regulation that makes it illegal to charge a price higher than a specified level" (Parkin et al., 2006:119). The Zimbabwean government has attempted to set a price ceiling for certain commodities i.e. fuel and food. This means that suppliers cannot set prices higher than the stipulated price. For a price ceiling to be effective according to Parkin et al. (2006:119), it has to be set below the equilibrium price; if set above the equilibrium point, it has no effect because market forces are not constrained by the price ceiling - the force of the law and market forces will not be in conflict.

Last year, the Zimbabwean government announced new price controls of basic food commodities in Zimbabwe to combat hyper-inflation. All companies producing and selling maize meal, which forms Zimbabweans staple diet, cooking oil, soft drinks, milk and sugar had to reverse recent price increases to their previous levels. The diagram below shows a price ceiling.

PRICE CEILING

Setting the price ceiling at a price below the equilibrium market price will create excess demand i.e. a shortage equal to Q3 to Q2. Therefore, a price ceiling creates a shortage whereby the quantity demanded exceeds the quantity supplied. When shortages occur a black market may develop. According to Parkin et al. (2006:120) "a black market is an illegal market in which the price exceeds the legally imposed price ceiling". This occurs where those consumers that have acquired the good sell it at an illegal price above the price ceiling. If we look at the situation in Zimbabwe black markets have emerged for commodities such as fuel. According to an article on the Zimbabwean watch by Makoni (2005) "the government has urged businesses not to increase prices of goods and services by more than 10%; a clause that, if previous years are anything to go by, will fall on deaf ears. The state is set to gazette new prices for basic commodities but analysts feel this move will only see essential goods disappearing from supermarket shelves and reappearing on the black market. 'It never rains but it pours'- a tired clichй but nonetheless a fitting summation of the plight of workers in the lower income bracket in Zimbabwe at the moment."

The resulting shortages create further problems as Sloman (1997) indicates; if the government merely sets prices and does not intervene further, the shortages will lead to alternative allocative mechanisms being have to be put in place. These might include:

 Allocation on a first come first served basis. This is likely to lead to queues developing or according to Sloman (1997) firms adopting waiting lists. Queues are a common feature of life in Zimbabwe. Most people have to queue up for fuel. The Government however, has allowed prices to rise and this has had the benefit of reducing queues but at the same time making it difficult for those on low incomes.

 Allocation by seller preference

 Allocation by government rationing: Sloman (1997:80) defines rationing as a state whereby the government restricts the amount of a good that people are allowed to buy. For example, in Zimbabwe, the municipality would cut power supply in certain areas for a certain period of time in order to save on electricity.

With regulated prices, suppliers find that they cannot charge what they had been charging for their products. The quantity supplied therefore decreases. Since the price ceiling is below the market price, consumers are now able to buy commodities at a lower price and as a result, market demand increases - quantity demanded exceeds quantity supplied therefore a shortage occurs as we mentioned earlier. A black market price would be the price at which the quantity demanded is equal to the quantity supplied at the controlled price (this is shown in the diagram below - Pb). The black market price is usually much higher than the regulated price and the market price. According to Parkin et al. (2005: 120) the black market price is equal to the maximum price that buyers are willing to pay. Those who are able to get commodities at the controlled price may be able to resell at the black market price therefore making a profit (shown as the shaded area in the diagram below). The diagram below attempts to explain the effects of price control on black market price.

EFFECTS OF PRICE CONTROL ON BLACK MARKET PRICE

Pb represents the black market price with Qb representing the Quantity supplied at this price.

Pe represents the equilibrium price with Qe representing the Quantity supplied at equilibrium.

Pc represents the price ceiling

Qd - Qb represents the shortage

The shaded