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S6 Economics

Price Mechanism and Price Control

Price mechanism is a system in a free enterprise economy where by prices in the market are determined by the market forces of demand and supply and prices act as an automatic signal in the allocation of resources.

Under price mechanism there is consumer sovereignty where a consumer takes an upper hand in influencing the decision of the producers concerning what to produce,  where to produce, for  whom to produce  when to produce  and how to produce. And there seems to be an invisible hand that allocates resources. 

It follows that whenever a consumer buys a product, he is casting a vote in favour of that product. The more he buys the greater the producer is willing to supply on the market. 

 

Price mechanism is based on certain assumptions which include the following; 

  1. Factors of production are mobile i.e. factors are free to move from where they are lowly paid to where they are highly rewarded. This condition applies in case of labour skills are easily acquired and thus labour can easily move from one occupation to another. 
  2. Perfect knowledge of the market. Consumers and producers have complete knowledge of the prices at which goods and services and factor inputs are bought respectively. There is no  persuasive  advertising  to  influence  the  pattern  of demand;  however  there  may  be informative advertising.
  3. Producers aim at maximising profits and produce highly priced commodities and therefore new firms are attracted by profits.
  4. There is no government intervention in the market transactions.
  5. The prices of goods and services are all determined by the forces of demand and supply.
  6. The government just keeps law and order.
  7. Consumers and producers are rational. The consumers aim at maximising satisfaction and therefore buy from the cheapest sources while the producers aim at minising costs so as to maximise profits.
  8. There is free entry and exist of firms in the production of goods and services. 
  9. There are many buyers and sellers in the market, none of whom can influence supply and price of a commodity. 

 

THE ROLE OF PRICE MECHANISM IN RESOURCE ALLOCATION IN AN ECONOMY:

POSITIVE ROLE: 

  1. Provides automatic adjustment between supply and demand. This is because an increase in demand for a commodity attracts more new firms into production of   that commodity results into increased supply thereby overcoming the shortage.
  2. Determines  the  type  of  technology  to  be  used  in  production.    The  producers  employ  the method of production which is efficient but at the same time affordable so as to produce high quality of products so as to attract more buyers and hence make more profits. 
  3. Promotes  consumer  sovereignty/determines  for  whom  to  produce  i.e.  producers  supply goods for those who can afford to buy them or for those who are ready and willing to buy at high price so as to enable them maximise profits.
  4. It determines the income distribution .Producers buy resources from resource owners and therefore income is distributed among the producers and resource owners. Those who own resources  which  are  highly  priced  earn higher  incomes  as  compared  to  those  who  own resources that are not highly priced.
  5. Determines  where  to  produce  /determines  the  location  of  the  production  unit.  Producers establish their business units where they can easily access customers who are ready to pay high prices for their products so as to enable them maximise profits.
  6. Determines when to produce. Production always takes place at the time  when consumers’ demand  dictates  so  and therefore  they  are  ready to  pay  high  prices.  This  is  common with products that are demanded seasonally. 
  7. Ensures production of better quality goods/ products. This is so because of competition in production as a result of many producers engaging in production.
  8. Guides on what to produce. Resources are allocated to production of those commodities that command high prices in the market so as to enable producers maximise profits.
  9. Ensures  efficiency  of  firms.  Resources  are  usually  allocated  to  the  production  of  those commodities where minimum costs are incurred in order to fetch high prices and maximise profits.
  10. Guides  in  resource  allocation  (factor market).  Factors  of  production  are  attracted  to  areas where they are highly priced or highly paid.
  11. Promotes/encourages innovations and inventions. This is intended to improve the method so as to minimise the costs of production in order to maximise profits.
  12. Provides variety of goods. This is so because there are many producers in the market who produce a variety of goods so meet the different tastes and preference of the consumers in order to maximise profits, hence widening consumer’s choice.

 

NEGATIVE ROLE OF PRICE MECHANISM IN RESOURCE ALLOCATION: 

  1. It leads to uneven distribution of income or Promotes income inequality/disparity. People with more productive resources earn more income than those with less productive resources.
  2. It  leads  to  the  emergency  of  monopoly  power  and  its  associated  evils.  This  happens  when inefficient firms are outcompeted and driven out of the industry and the few that remain enjoy monopoly power which may lead to production of poor quality products, overcharging consumers etc. 
  3. It leads to consumer exploitation and this is due to ignorance of the consumers about the market conditions which results into charging them very high prices for goods and services.
  4. It leads to emergency of unemployment. This happens when inefficient firms are outcompeted in business. Unemployment  may  also  arise  when  firms  adopt  capital  intensive  techniques  of production  in  bid  to  maximise profits  by  minimising  costs.  This  results  into  technological unemployment.
  5. There  is  divergence  between  the  private  and  social  benefits  and  costs.  This  is  because  price mechanism emphasizes the element of profit. Therefore producers aim at achieving their private benefits while creating social costs for the society pollution (water, air, and noise). 
  6. It does not adjust/respond to rapid structural changes in the economy. This is because it depends on the forces of demand and supply and for producers to make any changes may wait for signals from the consumers.
  7. It leads to wastage of resources this is due to wasteful competition and duplication of activities.
  8. Makes  the  economy  susceptible  to  economic  instabilities  such  as  price  fluctuations.  /leads  to economic instabilities  i.e.  inflationary  and  deflationary  tendencies.    The  producers  tend  to increase prices of goods and services with increased demand.
  9. Leads  to  distortion  of  consumer  choices  through  persuasive  advertisements/  encourages impulsive purchases.
  10. Inability  to  allocate  resources  to  public  and  merit  goods.  This  is  mainly  because  it  would  be impossible to charge them prices since free riders are not excluded in their consumption. In price mechanism producers aim at maximising profits so they tend to ignore such goods.
  11. Leads to misallocation of resources. Price mechanism may not allocate resources to priority areas /socially profitable ventures since it is guided by profit motive. This may lead to disappearances of cheap commodities on which the ordinary people survive.

 

 MERITS /ADVANTANTAGES/POSITIVE IMPLICATIONS OF PRICE MECHANISM:

  • It  encourages  the  production  of  better  quality  goods  because  production  is  competitive which encourages improvement in the quality of the products.
  • It promotes incentives for hard work leading to increased production. The profit motive encourages hard work, innovations and inventions hence increased productivity.
  • It encourages efficient  allocations of resources because producers produce in response to  consumer’s  demand therefore  cases  of  over  production  and  under  production  are avoided hence no wastage of resources.
  • It  avails  a  wide  variety  of  goods  and  services  to  consumers  because  there  are  many producers producing different commodities and this widens consumer’s choice. 
  • It encourages flexibility in production because producers adjust to changes in the market conditions basing on changing price for the commodity.
  • It is a cheap system to maintain/ it reduces the costs of administration because of limited government control since adjustments are automatic i.e. by forces of demand and supply.
  • It  encourages  arbitrage  i.e.  it  facilitates  regional  distribution  of  goods  which  benefits producers since goods are transferred from areas of plenty where prices are low to areas of scarcity where prices are high.
  • Provides  an  incentive  to  economic  growth.  Higher  prices  and  profits  encourage  large industrial establishments  to  spend  huge  sums  of  money  on  research,  new  and  better techniques  of production which leads  to more production of goods and services  hence economic growth.
  • It  helps  in  the  distribution  of  income.  Income  goes  only  to  those  who  own  resources. People owning large quantities of resources which are highly priced earn more income than those owning few resources.
  • It  decentralises  economic  powers.  This  is  so  because  individual  households  make  their own economic decisions/Promotes consumer sovereignty.
  • It  leads  to  increased  employment  opportunities.  This  is  due  to  increased  economic activities/ increased investment as people strive to make more profits.  

 

DEMERITS / DEFECTS/ SHORTCOMINGS/NEGATIVE IMPLICATIONS OF PRICE MECHANISM 

  • It  leads  to  uneven  distribution  of  income  or  income  inequality/disparity  i.e.  people  with  more productive resources earn more income than those with less productive resources.
  • It  leads  to  the  emergency  of  monopoly  power  and  its  associated  evils.  This  happens  when inefficient firms are outcompeted and driven out of the industry and the few that remain enjoy monopoly power which may lead to production of poor quality products, overcharging consumers etc.
  • It leads to consumer exploitation and this is due to ignorance of the consumers about the market conditions which results into charging very high prices of goods and services.
  • It leads to emergency of unemployment. This happens when inefficient firms are outcompeted in business. Unemployment  may  also  arise  when  firms  adopt  capital  intensive  techniques  of production  in  bid  to  maximise profits  by  minimising  costs.  This  results  into  technological unemployment.
  • There  is  divergence  between  the  private  and  social  benefits  and  costs.  This  is  because  price mechanism emphasizes the element of profit. Therefore producers aim at achieving their private benefits  while  creating  social costs  for  the  society  e.g  environment  degradation  of  resources, pollution (water, air, and noise).
  • Inability  to  adjust  to  rapid  structural  changes  in  the  economy.  This  is  because  it  is  forces  of demand  and supply  and  for  producers  to  make  any  changes  may  wait  for  signals  from  the consumers.
  • It  encourages  wasteful  competition  and  duplication  of  activities  and  this  result  into  resource wastage as a result of intensive persuasive advertisements.
  • Makes  the  economy  susceptible  to  economic  instabilities  such  as  price  fluctuations.  The producers  tend  to increase  prices  of  goods  and  services  with  increased  demand.  This  leads  to inflationary tendencies in the economy.
  • Leads to distortion of consumer choices through persuasive advertisements.
  • Inability  to  allocate  resources  to  public  and  merit  goods.  This  is  mainly  because  it  would  be impossible to charge them prices since free riders are not excluded in their consumption. In price mechanism producers aim at maximising profits so they tend to ignore such goods.
  • Leads to misallocation of resources. Price mechanism may not allocate resources to priority areas socially profitable ventures since it is guided by profit motive. This may lead to disappearances if cheap commodities on which the ordinary people survive. 

 

Factors influencing price mechanism in resource allocation.

  • Availability of capital. Adequate capital leads to proper allocation of resources to more productive areas in order to produce more goods and services thus promoting price mechanism in resource allocation. On the other hand, inadequate capital leads to inefficient allocation of resources due to reduced capacity to produce goods and services needed on the market thus limiting price mechanism in resource allocation. 
  • Level of labour skills. Existence of unskilled and semi-skilled labour leads to low productivity and efficiency in production of goods and services which limits the operation of price mechanism. On the other hand, highly skilled labour leads to high level of productivity and efficiency in the production of goods and services thereby promoting price mechanism in resources allocation. 
  • Level of entrepreneurial abilities. High level of entrepreneurial abilities promotes initiative to undertake business ventures with aim of making profits thereby promoting efficient allocation of resources. On the other hand, low level of entrepreneurial abilities limits initiative to undertake business ventures in fear of risks involved thereby limiting price mechanism in the allocation of resources. 
  • Degree of monopoly power/number of firms. High degree of monopoly power fails free operation of price mechanism as entry into economic activities by many firms is restricted to only one firm thereby failing price mechanism in resource allocation. On the other hand, where there is no monopoly, entry into economic activity by many firms is open which makes forces of demand and supply operate automatically to influence resource allocation.
  • Level of government interference. High level of government interference in form of setting prices for commodities, fixing quotas for producers, heavy taxation of the producers limits free operation of price mechanism in the allocation of resources. On the other hand, low level of government interference promotes price mechanism in resource allocation since forces of demand and supply operate automatically.
  • Level of ignorance/awareness of producers and consumers. High level of consumer ignorance denies them the right to consume from cheapest sources while producer ignorance denies them the right to discover the cheapest sources of raw materials leading to inefficient allocation of resources. On the other hand, high level of awareness about market conditions by both the producers and consumers leads to efficient allocation of resources by price mechanism.
  • Ability to forecast future trends. In a situation where producers are able to predict changes in conditions of demand and supply in future, price mechanism allocates resources effectively. On the other hand, price mechanism fails to allocate resources effectively where producers are unable to predict changes in conditions of demand and supply in future. 
  • The degree of rationality of consumers and producers. Price mechanism fails where producers aim at maximizing profits because they produce less output and consumers are after utility maximization by looking for cheapest goods and services. On the other hand, price allocates resources efficiently where producers aim at sales maximization which makes consumers increase consumption as goods and services become cheap.
  • The state of technology. Poor state of technology promotes high level of inefficiency due to increased costs of production thereby hindering efficient allocation of resources by price mechanism. On the other hand, better/ improved state of technology promotes high level of efficiency due to reduced costs of production thereby promoting efficient allocation of resources.
  • The state of infrastructure. Poor infrastructure in the form of poor roads, inadequate storage facilities and power shortages limits the ability of producers to exploit available resources and limits arbitrage leading to inefficient allocation of resources. On the other hand, developed infrastructure encourages producers to exploit available resources and promotes arbitrage due to reduced costs of production leading to efficient allocation of resources.
  • The degree of mobility of factors of production. High degree of factor mobility especially labour  promotes  price  mechanism  as  such  factors  can  easily  adjust  to  prevailing conditions in the level of economic activity basing on price indicators. On the other hand, high  degree  of  factor  immobility  limits  proper  allocation  of  resources  as factors  of production need significant training to acquire appropriate skills to perform certain tasks in alternative economic activities 

 

LIMITATIONS OF PRICE MECHANISM IN ALLOCATION OF RESOURCES

  • Government interference/ regulation. High level of government interference in form of setting prices for commodities, fixing quotas, imposing high taxes for producers fails free operation of price mechanism in terms of allocating resources. 
  • Existence of monopoly. High degree of monopoly power fails free operation of price mechanism as entry into economic activity by many firms is restricted to only one firm thereby failing price mechanism.
  • Immobility of factors of production. High degree of factor immobility limits proper allocation of resources as factors of production need significant training to acquire appropriate skills to perform certain tasks in alternative economic activities.
  • Inability to forecast future trends. Price mechanism fails to allocate resources effectively where producers are unable to predict changes in conditions of demand and supply in future.
  • Limited entrepreneurship. Low level of entrepreneurial abilities limits initiative to undertake business ventures in fear of risks involved thereby hindering efficient allocation of resources.
  • Irrationality of producers and consumers. Price mechanism fails where producers aim at maximizing profits because they produce less output and consumers are after utility maximisation by looking for cheapest goods and services.
  • Limited capital. Inadequate capital leads to inefficient allocation of resources due to reduced capacity to produce goods and services needed on the market. 
  • Limited skilled labour. Existence of unskilled and semi-skilled labour leads to low productivity and efficiency in the production of goods and services which limits the operation of price mechanism.
  • Poor infrastructures. Poor infrastructure in the form of poor roads, inadequate storage facilities and power shortages limits the ability of producers to exploit available resources and limits arbitrage leading to inefficient allocation of resources.
  • Ignorance about market conditions High level of consumer ignorance denies them the right to consume from cheapest sources while producer ignorance denies them the right to discover the cheapest sources of raw materials leading to inefficient allocation of resources.
  • Poor state of technology. Poor state of technology promotes high level of inefficiency due to increased costs of production thereby hindering efficient allocation of resources by price mechanism.
  • Political  instability. This  makes  the  production  of  goods  and  services  very  difficult  because investments are destroyed while new investors are scared.

 

REASONS FOR GOVERNMENT INTERFERENCE WITH THE PRICE MECHANISM

  • To reduce unemployment. The price mechanism causes unemployment by pushing out inefficient firms out of production and government interference aims at ensuring availability of jobs to citizens by ensuring that inefficient firms are not thrown out of business. 
  • To ensure economic stability. The government intervenes through price control to ensure stability in prices of goods and incomes of producers.
  • To ensure production of essential goods and services, as these may not be produced under the price mechanism.
  • To regulate production and provision of undesirable products (demerit goods) which do not promote economic and social welfare although they are profitable for example pornographic literature, dangerous cheap liquor, fire arms, drugs etc.
  • To reduce on the level of income inequalities that result from private ownership of resources and freedom of competition. The government interferes through progressive taxation so as to reallocate resources and attain equity in income distribution. 
  • To control the growth and regulate the activities of monopolies brought about by competition among producers. The government intervenes through high taxation of monopolists to avoid overcharging of the consumers and the production of low quality goods and services. 
  • To cover consumer ignorance due to market imperfections. This is done through encouraging formation of consumer associations. 
  • To reduce on social costs such as pollution and resource exhaustion that affect people’s welfare. This is through setting up regulatory bodies that regulate the actions of firms in resource exploitation. 
  • To cater for the provision of public and merit goods that cannot be provided through market forces of demand and supply because they are profitable.
  • To carry out proper economic planning for the entire economy and promote economic growth. This is through effecting necessary adjustments in time of structural changes for example, war, famine, floods etc, 

 

WAYS OF REDUCING THE DEFECTS/DEMERITS OF PRICE MECHANISM OR MEASURES   BEING TAKEN TO CONTROL SHORT COMINGS OF PRICE MECHANISM 

Introducing progressive taxation where the rich are taxed more than the poor to reduce income inequalities. In such a case, the revenue realised is used to provide essentials to the poor. 

Providing  incentives  to  protect/prop  up  weak  firms  to  enable  them  to  continue  producing  to reduce unemployment in case they drop out as a result of being outcompeted.

Issuing of licences. These are issued to regulate the activities of the investors by denying licences to producers of demerit goods. Licensing also controls over exploitation of resources.

Encouraging formation consumer’s protection organization/Associations. This is done to create awareness among   the consumers on issues concerning  the prices  and the quality of the goods on the market  so that they are not cheated and subjected to poor quality products.

Use  of  price  controls  to  ensure  stable  prices  e.g.  the  government  can  set  maximum  price  to protect consumers  from  being  over  charged  by  greedy  businessmen  and  minimum  price  to protect producers being exploited by the consumers during periods of bumper harvests which results into excess supply. 

Putting in place anti monopoly policies. There is need to control dominancy of monopolists through legislation and nationalisation. Adopting anti-monopoly policies for example, anti- merger laws, taxation o f monopoly profits, and removal of patents. This is intended to reduce on the formation and mal practices of monopoly and its associated evils.

Provision of public goods and merit goods. The government can allocate resources to the provision of public and merit goods which are usually ignored by private investors under price mechanism.

There is need for planning by the government to reflect structural changes, detect future needs of society and direct economic growth. 

Enact laws or putting laws in place/setting up regulatory bodies so as to regulate the exploitation of resources and avoid environmental degradation e.g. putting in place laws to protect wetlands. Setting up of regulatory bodies for instance electricity regulatory authority, national environment management authority, and national forestry authority. Such regulatory bodies are intended to control over exploitation of resources.

10.  The government can do rationing; this involves direct action by public authorities of apportioning scarce supplies to all households on a regular basis. Rationing helps in checking fluctuations due to acute shortages most especially for goods that are necessities. 

           

PRICE CONTROLS: 

Price control refers to the situation where the government fixes the prices of commodities either a maximum price to protect consumers or a minimum price to protect producers. Such a price which is fixed is referred to as an administered price. 

Minimum price Legislation:  This is the setting/fixing of prices of commodities by the government above equilibrium price below which it becomes illegal to buy the commodity. It protects producers. 

Maximum Price Legislation: This is the setting/ fixing of prices of commodities by the government below the equilibrium price above which it becomes illegal to sell the commodity. It protects consumers.  

Price support: This is where the government buys the surplus output in the market arising out of fixing the minimum price in order to avoid discouraging producers. 

 

MAXIMUM PRICE/PRICE CEILING  

Maximum price is the legal price set by the government below the equilibrium price above which it is illegal to sell the commodity. 

The major aim of fixing the maximum price is to protect consumers from being exploited by profit hungry traders. 

The maximum price is also referred to as price ceiling. 

An illustration of Maximum price/Price ceiling: 

In the diagram above, the maximum price is set at OPc below the equilibrium price OP.

 

REASONS FOR SETTING A MAXIMUM PRICE/PRICE CEILING: 

  1. To protect consumers from being exploited by the business men through overcharging.
  2. To encourage the consumption of a particular commodity, most especially merit goods.
  3. To reduce the gap between the rich and the poor because a maximum price enables the poor to acquire commodities at fair prices.
  4. To maintain price stability through controlling inflation by setting a maximum price.
  5. To control monopoly tendencies because producers are not expected to charge a price higher than the maximum price. 

 

MERITS OF SETTING A MAXIMUM PRICE:

  1. It protects the consumers from being over charged by the producers. 
  2. It helps to make commodities available to all income groups of people in the economy. 
  3. It reduces income inequalities since the low income earners are also able to   afford or acquire the basic   commodities since they are at fair prices. 
  4. It enables to maintain price stability in an economy since the sellers are not supposed to sell the commodities above the maximum price.
  5. It helps to control monopolistic tendencies and its associated evils such as overcharging, since the monopolist is not supposed to sell above the maximum price. 

 

DEMERITS/ DISADVANTAGES/NEGATIVE EFFECTS OF SETTING A MAXIMUM PRICE/PRICE CEILING 

  1. It leads to artificial shortage of goods where sellers hoard/ hide goods to create shortages on the market and then sell at higher prices
  2. It encourages trade malpractices such as smuggling and black marketing in an effort to sell goods at a higher price.  NB:  A black market is a situation where producers / sellers sell goods illegally at a price higher than the price fixed by the government. 
  3. It leads to under utilisation of resources because producers produce at excess capacity since they are discouraged by the low price.
  4. It  reduces  incentives  for  private  entrepreneurs  which  reduces  economic  growth  through tampering with profit margins of entrepreneurs.
  5. It increases government expenditure because of the high administrative costs incurred by the government to employ scouts and enforcement officers to ensure that goods are sold at regulated prices. 
  6. It leads to unemployment due  to reduced levels of investment since the maximum price discourages the investors.
  7. It leads to misallocation/inefficient allocation of resources. This is due to the unnecessary distortion of price mechanism in the allocation of resources 

 

MINIMUM PRICE/PRICE FLOOR:  

Minimum  price  is  the  price  set  by  the  government  above  the  equilibrium  price,  below which it becomes illegal to buy the commodity.

The price is set in order to protect the producers from being exploited by the buyers.

The minimum price is also referred to as Price Floor 

 A graph illustrating Minimum Price/ Price floor: 

A minimum price OP2 is set above the equilibrium price OPe and it leads to an increase in quantity supplied.      

 

REASONS FOR SETTING A MINIMUM PRICE: 

  1. To protect producers from being exploited by the buyers who normally offer low prices for their products. 
  2. To control price fluctuations of agricultural products that is affected by changing climatic conditions. 
  3. To encourage mass production of goods thus accelerating the rate of economic growth in an economy. 
  4. To  offset  an  economic  recession/  depression.  Minimum  price  stimulates  producers  to produce more which helps to pull the economy out of the recession / depression. 
  5. To  encourage  creativity  and  innovativeness  in  production,  the  minimum  price  is  set  to stimulate research in production so as to produce more output hence increasing profits for the producers. 
  6. To minimum the exploitation of labour by the employers in the case of minimum wages. 

 

MERITS/ ADVANTAGES/ POSITIVE EFFECTS OF SETTING A MINIMUM PRICE:

  1. Protects producers from being exploited by consumers, since consumers are not supposed to buy commodities below the set price.
  2. Enables  producers  to  realise  stable  incomes.  This  is  so  because  the  producers  sell  their commodities at stable prices.
  3. Leads  to  increased  production  of  goods  and  services.  This  is  due  to  the  increased investment resulting the high minimum price set by the government. 
  4. Helps  an  economy  out  of  an  economic  depression  /  recession.  This  is  so  because  the minimum price stimulates production in the economy thus offsetting the economy out of an economic depression/ recession. 
  5. Helps to establish industrial peace. This is so because it reduces strikes by workers who complain of low wages when the government intervenes to fix a minimum wage for labour. 
  6. Helps  to  reduce  income  inequalities  between  the  producers  of  primary/agricultural products and those who work in the industrial sector. This is so because the producers of primary products earn stable incomes due to minimum price set by the government.
  7. The  minimum  wage  increases  aggregate  demand  leading  to  increased  production  and investment in the economy. This is so because of the increased purchasing of the people. 

 

DEMERITS/ DISADVANTAGES/ NEGATIVE IMPLICATIONS OF SETTING A MINIMUM PRICE: 

  1. Leads to unmanageable surpluses because the minimum price motivates the producers and therefore  produces  more  goods  than  demanded.  The  excess  supply  causes  storage problems.
  2. It  leads  reduction  in  social  welfare  due  to  the  high  cost  of  living.  This  is  because  the minimum price is set above the equilibrium price and therefore it becomes expensive for the buyers to purchase from the producers.
  3. It leads to high administrative costs. This arises as a result of government employing scouts to monitor the set price in order to ensure that goods are sold at the fixed price. At the same time, the government is forced to buy the surplus output through price support system.
  4. It increases the cost of production. This arises out of high costs of raw materials, increased cost of labour in case of minimum wage.
  5. It leads to technological unemployment. This arises a result of adopting capital intensive techniques of production due the high costs of labour. 
  6. Minimum  wages  cause  rural  urban  migration  and  its  related  evils.  This  is  because  most production units are located in urban areas, and when the minimum wage is set, it attracts people from rural areas to urban areas with hope of enjoying such high wages, but majority of such people fail to get those jobs, this leads to open urban unemployment, congestion in towns etc. 
  7. It leads to misallocation/inefficient allocation of resources. This is due to the unnecessary distortion of price mechanism in the allocation of resources.  

 

Reasons for legislating prices by the government include; 

  • To protect consumers  
  • To control monopoly power 
  • To control inflation/ ensure price stability 
  • To protect producers from being exploited 
  • To increase output 
  • To make commodities available to all groups of people 
  • To help establish industrial peace
  • To stabilise producers’ incomes 
  • To reduce income inequality 
  • To help an economy offset an economic depression

Demerits of price legislation;

  • Leads to unmanageable surpluses 
  • Leads to unemployment due to reduced investment 
  • It reduces incentives for private entrepreneurs 
  • Leads to shortages in supply due to increased demand 
  • Leads to inefficient allocation of resources due to distortion of price mechanism 
  • It is expensive for the government to enforce because of high administrative costs.
  • It encourages trade malpractices, e.g. smuggling 
  • It leads to increased costs of production 
  • It leads to reduction in social welfare due to high costs of living 
  • Production at excess capacity leads to underutilisation of resources.

Discussion

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