Market Inefficient - Price Ceiling

            Market is considered efficient when the market is in an equilibrium position where the point of demand curves intersects the supply curves. A market is also efficient when the consumer and producer surplus is maximized.When a market is not efficient, it is considered as a market failure, which is a situation when resources  could not be allocated efficiently due to some factors. (Business Dictionary, 2013). 

Below is a graph showing a efficient market :

            Based on the diagram above, the market is considered efficient as the consumer and producer surplus is maximized and the quantity demanded and supplied fall on the equilibrium point. Consumer surplus is the excess of the benefit received from a good over the amount paid for it while producer surplus is excess amount received from the sale of a good over the cost of producing it. In this case, the market is efficient when the price of the good is RM 40 and the quantity is 100 units as both fall under the equilibrium point.

            However in the real life, market is usually inefficient due to some causes. One of the causes would be government intervention. Government interventions can caused a market to be inefficient. One of the example of government intervention that caused an inefficient market is price ceiling or also can be known as price cap. Price ceiling or price cap is a law or regulation that sets a maximum price to prevent it from rising above a certain level, any prices above the price ceiling is considered illegal. (Sloman, Wride and Garratt, 2012). In order for a price ceiling to be effective, it needs to set below the market equilibrium. For instance, during the festival seasons in Malaysia such as Chinese New Year, government will set a maximum price for certain products. According to The Star (2013), government had set the price ceilings for 13 items of goods for the Chinese New Year celebration from February 6 to 17. Among the items are chickens, eggs, fish, pork and cabbages. During the Chinese New Year, the demand of these products will definitely increases as the Chinese will buy these products to celebrate Chinese New Year. 

http://thestar.com.my/news/story.asp?file=/2013/1/31/nation/20130131151552&sec=nation

            Due to the human nature, sellers of these products will increase their prices to maximize their profit as the demand for the products had increased. When the prices of these products increased, the poor people could not afford to consume these products and this will not be fair. So, government came in by setting a maximum price for these products to be sale. However, this action will causes a market failure where the market is not is its equilibrium position. Below is a graph showing the price of chicken over the quantity demanded.

            For the buyers, it is of course a benefit for them as they pay a lower price than usual to get the same product. But for the sellers, if the price ceiling is set below the equilibrium price, they will get a lower profit compared to non-festival seasons. From the above diagram, the equilibrium price for a chicken is P0, but after the price ceiling is imposed, the price of a chicken dropped to P1. Sellers are actually earning lesser of the profit per chicken and consequently, they will supply lesser chicken. And for buyers, when the price of chicken falls, the demand for chicken will surely increase. As a result, a shortage occurred. Some sellers are not likely willing to sell their chicken at the price of P1 and the supply of the chicken will be lesser. Shortage of the chicken may causes a deadweight loss whereby the quantity supplied now is become lesser, Q0 to Q1. 

            Hence, due to the decrease in the quantity supplied, buyers might not be able to get chicken in a single market, and hence, they will need to search from another market. As a result, searching activities occurred. Now, the opportunity cost for the chicken will not just be the money spent to buy it, but also include the time spent on searching for it.

            Moreover, some of the sellers may not want to sell their chickens in the price of P1. So, a black market will be formed where the sellers sell products higher than the price ceiling. Based on the diagram, the price of a chicken in a black market is P2, which is much higher than the price ceiling. Due to the inelasticity of the chicken, Chinese buyers will still buy it no matter what the price is because Chinese New Year is their important festival. For middle and higher class of income earners, the higher price of chicken will not really affect much, but for those low income earners, they will suffer as they are not afford to purchase chicken at such a high price.

            The shortage however will creates further problems. Firstly, allocation on a 'first come, first served' basis. Whoever that come earlier will get the chicken and for those who are late, they get nothing. This is definitely not fair because this has misused the purpose of price ceiling. Price ceiling is set by the government to help the low income earners to get chicken during the festival season, but due to the 'first come, first served' basis, middle or higher class income earners will still go and queue to get the chicken, resulting some of the low income earners could not get chicken during the festival.

            Furthermore, some sellers would tend to decide which buyers should be allowed to buy from them but usually they will give preference to their relatives, friends and regular customers. What about others? They might not be able to get chicken during the Chinese New Year.

            Neither of above is fair, and as a result, rationing system is introduced by the government. Buyers now are only allowed to buy a certain amount of chicken. They could be issued with a set number of coupons for each item rationed. 

Price Ceiling in other countries

            On the other hand, price ceiling or price cap has caused some issues in the other country too. For instance, Bahamas. 

Below is the link of the the news article in Bahamas :

http://www.thenassauguardian.com/index.php?option=com_content&view=article&id=37958:daguilar-blasts-price-control-regime&catid=40:business&Itemid=2

           Bahamas is a country that consists of more than 700 islands in the Atlantic Ocean. Its economy is mainly driven by the tourism. The government of Bahamas set a price cap on some basic foods such as cooking oil, eggs, tuna and cheese. But here is the issue, the government has set the price ceiling way too low and it forced the sellers to sell the foods below their cost. Based on Todd (2013), in his report in The Nassau Guardian, a major food retailer is calling for an end to the ineffective price control.  

            The reason why food retailers opposed the price ceiling is because they are making a loss when they sell those food products as the price set by the government is below their cost of producing the foods. Consequently, supermarkets in the Bahamas increase the price of other products in order to cover the loss they make in selling the price controlled foods. The CEO of a big food retail company, Gavin Watchorn, said that the price cap on those foods does not work at all.

            So, that is the issue when the price cap is set too low. Sellers could not even cover their costs if they sell those food products. If this problem could not be solved, there will be a very serious matter of shortage in Bahamas. Some sellers would have to stop selling those products as they could not make any profit from it. As a result, the supply of those products will decreases and hence creates a shortage.

            Meanwhile in Ethiopia ;

http://www.voanews.com/content/price-controls-cause-chaos-in-ethiopian-markets-114585164/134022.html

           The price cap has also caused the same problem. Based on Voice of America (2011), although the price cap was set to reduce the grocery bills of some low income earners, but now there are some basic items are disappearing from the store shelves.  

            The price cap was set too low until the sellers are making losses. In the first few days, the price cap actually went into effect as now the low income earners are afford to buy some basic groceries. However, sellers are unhappy about it because the price cap was set too low in order for them to make a profit. In the article of the Voice of America (2011), one of the seller said, ' This is way too much for us. We are small traders. We don’t make much money. We get everything on credit, so when this stock is gone, we are closing up shop.' As we can see, sellers are getting frustrated as their profit could not actually cover the losses they make in selling those price controlled staples foods.

            As a conclusion, price ceiling can only goes into effect if government study hard in the effects that may be encountered if price ceiling is imposed. Government should never simple impose a price ceiling without serious consideration about it. Furthermore, government should be always concerning about the market when the price ceiling is imposed and make sure that they do not cause more problems to the economy of the country.

References

Business Dictionary (2013) Market Failure. [online] Available at: http://www.businessdictionary.com/definition/market-failure.html [Accessed: 4 Jun 2013].

Sloman J., Wride A. and Garratt D. (2012) Economics. 8th ed. London: Pearson.

Todd, J. (2013) D' Aguilar blasts price control regime. The Guardian, [online] 22nd March. Available at: http://www.thenassauguardian.com/index.php?option=com_content&view=article&id=37958:daguilar-blasts-price-control-regime&catid=40:business&Itemid=2 [Accessed: 25 May 2013].

Voice of America (2011) Price Controls Cause Chaos in Ethiopian Markets. [online] Available at: http://www.voanews.com/content/price-controls-cause-chaos-in-ethiopian-markets-114585164/134022.html [Accessed: 4 Jun 2013].

 Wong, P. and Jason, Y. (2013) 13 items placed under CNY price control scheme. The Star, [online] 31st January. Available at: http://thestar.com.my/news/story.asp?file=/2013/1/31/nation/20130131151552&sec=nation [Accessed: 25 May 2013].