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Consequences of Introducing a Minimum Price in the Market

With the aid of a diagram, explain the consequences for consumers and producers of introducing a minimum price in the market for a product. [8]

Category:

Microeconomics

CIE AS level November 2021

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Answer

Tip: Divide your essay into two parts:

1. Consequences for consumers of introducing an effective minimum price in the market for a product.
2. Consequences for producers of introducing an effective minimum price in the market for a product.

(Step 1: Define 'minimum price' in the introduction)

A minimum price is a price floor set by the government or some other agency. The price is not allowed to fall below this level. Controls are only valid in markets where the minimum price is set above the normal equilibrium price.

A minimum price impacts both consumers and producers. This can be explained using the following diagram:

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(Step 2: Explain the effect of minimum price on consumers)

➡️Introducing an effective minimum price in the market for a product has several consequences on consumers.

1️⃣ Consumers will need to pay a higher price compared to the price that would have been charged where demand and supply in a market were in equilibrium.

In diagram 1, the equilibrium price is initially Pe. If the government introduces a minimum price above the equilibrium price, the new price paid by consumers will be P1.

2️⃣A minimum price will discourage the consumption of the product by consumers

In diagram 1, if the government introduces a minimum price above the equilibrium price at P1 then the quantity demanded will fall from Qe to Q1 because consumers are prepared to buy less at a higher price.

3️⃣A minimum price will be beneficial for consumers if the product is a demerit good.

Governments can use legislation to enforce minimum prices for demerit goods such as tobacco products and alcohol, so as to discourage consumption.

4️⃣Informal markets

There is a danger that an informal market will develop especially for sought-after products like imported alcohol and cigarettes. Consumers will be more than happy to buy from dealers offering these goods at less than the regulated minimum price.

5️⃣The impact of the minimum price is likely to be regressive, with a more significant impact on the 'poor'.

(Step 3: Explain the effect of minimum price on producers)

➡️Introducing an effective minimum price in the market for a product has several consequences for producers.

1️⃣ The minimum price will help producers to increase their incomes

2️⃣There will be an excess supply that consumers do not buy at the higher minimum price

The problem in diagram 1 is that at price Pe, the quantity supplied, Q2, is much bigger than the quantity demanded, Q1. There is a surplus (excess supply).

The normal response to such a situation of excess supply is for the price to fall. To prevent the price from falling, the government steps in and buys up the excess supply to prop the price up.

In other words, of the total amount Q2 supplied at price Pe, regular consumers demand and purchase Q1. The remainder, Q1 – Q2, must be purchased by the government.

(Step 4: Conclude)

To conclude, the overall impact of the minimum price demands on price elasticity. When consumers are unresponsive (inelastic) in terms of their response to a minimum price, the reduction in consumption will be relatively small. Similarly, when supply is inelastic, producers cannot increase production quickly, with the result that the surplus is small.


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MARKING SCHEME



For Knowledge and Understanding

For correct diagram:

Axes correctly labelled: P/Q (1 mark)

Minimum price shown above equilibrium in diagram (demand and supply curves need to be correctly labelled) (1 mark)

KU: 2 marks maximum

For Application Consequences for consumers of the establishment of a minimum price in a market (up to 3 marks)

Consequences for producers of the establishment of a minimum price in a market (up to 3 marks)

APP: 6 marks maximum

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