Market Function: Definition, Operating Procedures
In a free-market economic system, government intervention is often met with scepticism by proponents of free markets. However, many countries do not adhere to a purely free-market system, and government intervention is common. One such intervention is the setting of price floors and price ceilings, which can disrupt the market mechanism.
The market mechanism, a system where supply and demand determine the price and quantity of goods traded, is crucial for achieving market equilibrium. This equilibrium point is where the quantity supplied equals the quantity demanded, ensuring an efficient allocation of resources.
However, government interventions such as price floors (e.g., minimum wage) and price ceilings (e.g., rent control) can disrupt this market mechanism. Let's explore how these interventions work and their effects on the market.
A price ceiling sets a maximum price below the market equilibrium price, resulting in excess demand or shortages. For instance, rent control is a common price ceiling that can lead to housing shortages. In the given example, if a business produced 60 shirts and initially set its price at Rp170,000, it would sell only 10 shirts. To address this, the business lowered the price to Rp130,000, eventually selling 50 more shirts at this price.
Conversely, a price floor sets a minimum price above the equilibrium price, causing excess supply or surpluses. This can lead to wasted resources and inefficiencies, such as unemployment in the case of minimum wage laws if set too high.
Both interventions move the market away from its equilibrium quantity and price, resulting in what economists call deadweight loss—a loss of economic efficiency where potential gains from trade are not realized. Price floors reduce transactions by raising prices and lowering quantity demanded, while price ceilings increase quantity demanded but reduce quantity supplied, each causing misallocation of resources relative to the efficient market outcome.
It's essential to understand that price serves as a signal for resource allocation in the market mechanism. Price increase is a signal for producers to increase production, and price fall is a signal for consumers to reduce demand. Government intervention in the form of price floors and price ceilings disrupts these natural market signals, leading to inefficient resource allocation compared to undistorted market equilibrium conditions.
In some cases, government intervention is necessary for providing public goods, as private companies may be reluctant to do so due to unprofitability. However, it's crucial to consider the potential consequences of such interventions on market dynamics and overall economic efficiency.
Understanding concepts such as consumer surplus, excess supply, excess demand, market equilibrium, deadweight loss, auction types, the law of demand, and the differences between a movement and a shift in the demand curve can provide a deeper understanding of market dynamics and the implications of government interventions.
[1] Economics Online. (n.d.). Price Floors and Price Ceilings. Retrieved from https://www.economicsonline.co.uk/microeconomics/market-structure/price-floors-and-price-ceilings.html
[2] Investopedia. (2021). Price Ceiling. Retrieved from https://www.investopedia.com/terms/p/priceceiling.asp
[3] Investopedia. (2021). Price Floor. Retrieved from https://www.investopedia.com/terms/p/pricefloor.asp
[4] Khan Academy. (2021). Price Floors and Price Ceilings. Retrieved from https://www.khanacademy.org/economics-finance-domain/microeconomics/elasticity-and-market-structure/price-floors-and-price-ceilings/v/price-floors-and-ceilings
[5] The Balance Small Business. (2021). Price Floors and Price Ceilings. Retrieved from https://www.thebalancesmb.com/price-floors-and-price-ceilings-2879368
In the context of a free-market economic system, price floors and price ceilings are government interventions that can disrupt the market mechanism, as they set minimum and maximum prices for goods, respectively. These interventions can lead to inefficiencies, such as housing shortages due to rent control (an example of a price ceiling) or excess supply of goods or unemployment due to minimum wage laws (an example of a price floor).
