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 Co

st

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

80Quantity

demanded

120Quantitysupplied

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

demand

Supply

Equilibrium

EquilibriumWages / 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

The price floor and ceiling are being necessary to control prices of essentials otherwise not affordable for middle and lower class.

It is also effecting to petroleum and agriculture industry badly because they produce essential and government cannot afford high rates of these products.