Price support controls; why political governments love, and economists hate them?

You can see different countries deploying price support controls in shape of a price floor, export/import quotas, subsidies, etc. The most important is the price floor in wage and agriculture markets.

The price floor is the minimum price of a commodity that governments announce and ensure to be implemented above the market price equilibrium. Such product can’t be sold below that amount. The cabinets take this measure to avoid a further decrease in the price of that commodity.

You can take price floor as a guarantee or contractual binding that the government shall purchase the surplus commodity as it is a natural result when price controls implemented. For example, the government of Pakistan has been deploying price floor on the grain for last many years. The growers produce a surplus which can’t be consumed in the market. If the government does not purchase the excess, it will fail the price support policy.

You can set a price floor below market equilibrium, but that policy is bound to fail as the market is already functioning above that minimum price.

Agriculture Market and Price Floor

Almost all governments play an active role in the agriculture products markets. However, different methods are deployed by different countries depending upon their skills and financial spaces. Whatever plans they try their first purpose has been to amass political support of the farmers. The vast rural population and spread bring more legislatures to the governance which in turn has to work for the most deprived strata of the society. 

In developing countries, the people from rural areas try to move toward cities for a better life, education, health and other civic facilities. It not only puts a lot of pressure on the local governments but also create a shortage of farm workers. The parties consider it proper to deploy price support controls to keep farm labor into villages.

Besides political and administrative problems, it is a reality that the farmers are the most disadvantageous group of the society. The size of their products depends upon the weather conditions which are out of their controls. Similarly, their income rises and falls following the weather patterns. One year they are rich and the other bankrupts.

Surplus Problem and Solutions

When you draw a graph of the price floor, you see that consumers are not ready to purchase the product at a price fixed by the government, so quantity demanded decreases. The consumers purchase quantity at a price which is equal to price floor or at a point where demand curve intersects the floor line on the graph.

On the other hand, the price floor is more than price equilibrium, so producers supply more than supply equilibrium. They continue supplying to the point where marginal cost equals to price floor or where supply curve intersects the price floor line. This situation increases the supply more than the quantity demanded and resulted in a surplus. If this surplus is not handled and removed from the market, it shall decrease the price below the market equilibrium and fail the policy.

This surplus creates an inefficiency which is called a deadweight loss.

Deadweight loss is an inefficiency in the market due to a surplus of the producer as well as the consumer. In other words, when price support is enforced, it disturbs the market equilibrium and results in a loss to the producers as well consumers.

How to avoid Surplus of Price Support controls?

It was the most interesting part of the policy that heated my debate with Prof. Mukul Asher in LKY School of Public Policy, NUS of Singapore. He easily brushed away my arguments. However, he agreed that governments all over the world take one or more of these measures yet such policies always fail to secure the desired results.

A-      The governments purchase the surplus resulted in the process of the price support controls. Pakistan government has to purchase the whole surplus of wheat every year, through federal and provincial food departments.

B-      Another option is to enforce the price floor strictly with implementing machinery. However, it has a flip side. The people who sell their goods on floor price get rich, but those who fail to do so are destroyed. You can see the same phenomenon in wage market on fixation of minimum wages.

C-      The governments also try to control the production side to avoid surplus in the market. The United States government has done it many a time in the history. The farmers are asked either not to grow the targeted crops or even destroy it for some specified compensations.  This policy also creates a problem as more producers enter the market to cash in on the price support controls.

Many governments subsidize price-supported commodities. It enhances consumption of such product and surplus is purchased at lower prices. A subsidy is a kind of negative taxation.

Why Price Controls Fail (1)

Why Govt. Price Mechanism Fails (2)

A Case for Price Ceiling

Public Policy Options

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