A maximum price below equilibrium causes a shortage; a minimum price above equilibrium causes a surplus.
A maximum price is a legal upper limit on price. It is set below the equilibrium price to make a good affordable, such as rent or staple food. At this lower price, quantity demanded rises and quantity supplied falls, creating a shortage.
A shortage leads to problems. Queues form, sellers choose whom to sell to, and illegal black markets may appear where goods sell above the maximum.
A minimum price is a legal lower limit, set above equilibrium. It aims to raise producers' incomes, as with some farm prices, or to discourage consumption, as with a minimum price for alcohol.
At the higher price, quantity supplied rises and quantity demanded falls, creating a surplus. The government may have to buy and store the surplus, which is costly.
- Maximum price
- Legal ceiling below equilibrium; causes a shortage.
- Minimum price
- Legal floor above equilibrium; causes a surplus.
- Black market
- Illegal trading at prices above the legal maximum.
Worked example: Analysing a maximum price on rice
Suppose a government sets a maximum price for rice below the market price.
- Aim: make a staple food affordable for poor households.
- Diagram: Pmax sits below the equilibrium price.
- Effect: quantity demanded rises to Qd and quantity supplied falls to Qs, so there is a shortage.
- Consequence: some buyers get cheaper rice, but others cannot find any; black markets may develop.
Watch out for this
A maximum price above the equilibrium price causes a shortage.
A maximum price above equilibrium has no effect, because the market price is already lower. It must be below equilibrium to change anything.
Check your understanding
A government sets a minimum price for milk above the equilibrium price. What is the likely result?
- A surplus of milk, because quantity supplied exceeds quantity demanded
- A shortage of milk
- No change, because minimum prices do not affect markets