Chapter 5

The market system 3

price instability and
government
intervention

w w w . s t ud y i n t e r a c t i v e . o r g

57

CHAPTER 5

P R I C E IN S T A B IL IT Y A N D G O V E R N M E N T IN T E R V E N T I O N

CHAPTER CONTENTS
LEARNING OUTCOMES -------------------------------------------------- 59
PRICE INSTABILITY IN PRIMARY MARKETS -------------------------- 60
WEATHER AND AGRICULTURAL OUTPUT ------------------------------ 61
PRICE STABILISATION POLICIES-------------------------------------- 62
MAXIMUM AND MINIMUM PRICING IN GOODS MARKETS----------- 63
MINIMUM WAGE POLICIES --------------------------------------------- 65

58

ww w. stu dyi n t e ra cti v e .or g

CHAPTER 5

P R I C E IN S T A B IL IT Y A N D G O V E R N M E N T IN T E R V E N T I O N

LEARNING OUTCOMES
(a) Identify causes of instability of prices in markets for primary goods.

(b) Explain the impact of instability of prices on incomes of producers and the
stability of the industry.

(c) Explain the effects on prices, producer revenues and market equilibrium of
government policies to influence prices in markets.

(d) Illustrate the impacts of price regulation in goods and factor markets.

59

ww w. stu dyi n t e ra cti v e .or g

CHAPTER 5

P R I C E IN S T A B IL IT Y A N D G O V E R N M E N T IN T E R V E N T I O N

PRICE INSTABILITY IN PRIMARY MARKETS

The three types of business activity include:
o Primary (extraction / harvest of raw materials)
o Secondary (manufacturing)
o Tertiary (service industries)
Primary goods include:
Basic foodstuffs
Primary raw materials
Minerals and metals.
Cyclical variations in the price and supply of primary goods are caused by a
combination of unforeseen shocks, e.g. extreme weather, and the lag-time needed
to adjust supply accordingly.

60

ww w. stu dyi n t e ra cti v e .or g

CHAPTER 5

P R I C E IN S T A B IL IT Y A N D G O V E R N M E N T IN T E R V E N T I O N

WEATHER AND AGRICULTURAL OUTPUT

Farmers benefit from poor
. Climate change has led to increasingly
varied harvests, consequently farmers incomes are prone to vary considerably in
the absence of government intervention.
The key contributing factors, other than the impact of climate include:
(i)

Food being a necessity.

(ii)

Demand for food being inelastic.

The impact on total revenue is such that:

(i)

Poor harvest

leads to increased revenue.

(ii)

Good harvest

leads to reduced revenue.

Poor Harvest:
$
S0

P0

D0

Qty
Good Harvest:
S0

P0

D0

Qty

61

ww w. stu dyi n t e ra cti v e .or g

CHAPTER 5

P R I C E IN S T A B IL IT Y A N D G O V E R N M E N T IN T E R V E N T I O N

PRICE STABILISATION POLICIES

Governments often intervene within agricultural markets, with variable results.
Buffer stocks

Direct payment schemes

Subsidies and set-aside

Consequences of government intervention in agricultural markets

62

ww w. stu dyi n t e ra cti v e .or g

CHAPTER 5

P R I C E IN S T A B IL IT Y A N D G O V E R N M E N T IN T E R V E N T I O N

MAXIMUM AND MINIMUM PRICING IN GOODS MARKETS

Governments may attempt to control prices through the use of maximum prices
(price ceiling) and minimum prices (price floors). Maximum prices are used when
the free market achieves a sub-optimal level of access to goods/services whereas
minimum pricing tends to apply when consumption levels have wider unintended
social costs.

Exercise 1
Consider the following scenario whereby the government introduces a price ceiling
in the market for widgets.

$
S0

P0
Max
Price
D0

Q0
1

(a)

Excess of demand over supply

Excess of supply over demand

An increase in the price

Nothing
(b)

Qty

What will be the impact of the above?

Consider the
equilibrium.

impact

of

setting

maximum

price

above

Consequences include:

63

ww w. stu dyi n t e ra cti v e .or g

CHAPTER 5

P R I C E IN S T A B IL IT Y A N D G O V E R N M E N T IN T E R V E N T I O N

Exercise 2
Consider the following scenario whereby the government introduce a price floor in
the market for strawberries.
$
S0
Min
Price
P0

D0

Q0
2

(a)

Excess of demand over supply

Excess of supply over demand

A reduction in the price

Nothing
(b)

Qty

What will be the impact of the above?

Consider the
equilibrium.

impact

of

setting

minimum

price

below

Consequences include:

64

ww w. stu dyi n t e ra cti v e .or g

CHAPTER 5

P R I C E IN S T A B IL IT Y A N D G O V E R N M E N T IN T E R V E N T I O N

MINIMUM WAGE POLICIES

The purpose of minimum wages are to ensure:
Low paid workers have an acceptable standard of living.
Skills shortages are addressed in certain industry sectors.
The impact of minimum wage restrictions:
Wage
rate

SL
Min
Wage

W0

DL

Qty of labour rate

The resulting effects include:

65

ww w. stu dyi n t e ra cti v e .or g

CHAPTER 5

66

P R I C E IN S T A B IL IT Y A N D G O V E R N M E N T IN T E R V E N T I O N

ww w. stu dyi n t e ra cti v e .or g