## DragIT Maximum prices

Government may set a ceiling for prices below the market equilibrium in order to benefit consumers. This is referred to as a 'maximum' price because suppliers are not allowed to charge a higher price. In the UK, the price of a standard loaf of bread was set by the government right up to the early 1970s. Low maximum prices are often used in developing countries as a means of helping the large numbers of urban poor.

Assume that the domestic market price for wheat is £5 (which is also the world price of wheat). In the diagram below drag the 'low maximum price' line to a level that reduces this country's market price of wheat by 20 per cent.

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##### Maximum prices

In the above situation which of the following will be true? (Select all those statements which are true)

 a) There would be a shortage of 5,000 tonnes of wheat per annum. b) Producers' incomes will fall by 36 per cent. c) Consumption would increase by 20 per cent. d) Supply of wheat would fall by 1/5. e) Future supplies of wheat will be less because farmers will have less incentive to plant wheat. a) Yes, that's correct. There will be a shortage, but it will be 10,000 tonnes.a) No, that's not right. There will be a shortage, but it will be 10,000 tonnes.b) Yes, that's correct. Original income was £125,000 (£5 × 25,000). New income is £80,000 (£4 × 20,000).b) No, that's not right. Original income was £125,000 (£5 × 25,000). New income is £80,000 (£4 × 20,000).c) Yes, that's correct. Although demand has increased by 20 per cent (from 25,000 to 30,000 tonnes per annum), consumption will fall to 20,000 tonnes as that is all that is being produced (assuming none in store).c) No, that's not right. Although demand has increased by 20 per cent (from 25,000 to 30,000 tonnes per annum), consumption will fall to 20,000 tonnes as that is all that is being produced (assuming none in store).d) Yes, that's correct. Supply would fall from 25,000 to 20,000 tonnes per annum.d) No, that's not right. Supply would fall from 25,000 to 20,000 tonnes per annum.e) Yes, that's correct.e) No, that's not right. The statement is correct.

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##### Maximum prices

In the above situation, which of the following will be true? (Select all those statements which are true)

 a) Over time, fewer people will be engaged in wheat farming, choosing instead to seek work in more profitable occupations - probably in the local town. b) Rationing may have to occur, which can be unfair on those in the most need. c) A black market in wheat could evolve. The black market price could reach £6.00 per tonne. d) If the world price is £5.00 and the black market price reaches £6.00, there is every reason to believe that smuggling might occur! e) Policing the policy (i.e. stopping the black market and smuggling) would ultimately have to be paid for by the taxpayer. a) Yes, that's correct. The statement is true.a) No, that's not right. The statement is true.b) Yes, that's correct. The statement is true.b) No, that's not right. The statement is true.c) Yes, that's correct. The statement is true.c) No, that's not right. The statement is true.d) Yes, that's correct. The statement is true.d) No, that's not right. The statement is true.e) Yes, that's correct. The statement is true.e) No, that's not right. The statement is true.