What would be the economic consequences if prices were fixed by the government?

Answer Details

When the government fixes prices away from the free-market equilibrium, the economic consequences depend on whether the fixed price is below or above equilibrium.

Price fixed below equilibrium (a maximum or ceiling price), often to protect consumers of essential goods:

• Excess demand (shortage): quantity demanded exceeds quantity supplied, so goods run out.
• Emergence of a black market: scarce goods are resold illegally at prices above the controlled price.
• Hoarding and rationing: sellers hold back goods and formal rationing or queuing may be introduced to share the limited supply.
• Fall in quality as sellers cut standards, and a fall in supply as production becomes less profitable.

Price fixed above equilibrium (a minimum or floor price), often to protect producers, for example a guaranteed price for farmers or a minimum wage:

• Excess supply (surplus): quantity supplied exceeds quantity demanded.
• Government or agencies may have to buy and store the surplus, raising costs.
• Resources are misallocated into over-production, and a minimum wage above equilibrium can create unemployment.

The key point is that a controlled price prevents the market from clearing, so either a persistent shortage or a persistent surplus results, together with side-effects such as black markets, rationing and misallocation of resources.