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Price Floor as Government's Interventionist Policy

Question:

Discuss about the Regulatory Failure in Electricity Sector Reforms.

21st century is the era of globalisation, where economies around the world are indulging with each other through trade to gain sustainable growth. Since last few decades, ideas like free trade has came into existence to enhance the scope of international trade through banishing the trade barriers like price ceiling or price floors, which are being used by the government to gauge the market situation (Rodrik 2017). However, it’s been a long spending debate that whether the government should take interventionist policy to check the market or not. International trade is one of the topics, which has been under continuous research since decades due to its magnitude and complexity. Various researchers has shown diversified views regarding the government’s interventionist policy under the open market scenario, where some argue it to be essential for stability of the market, on the other hand some argue government’s intervention lead to inefficient allocation of resource (Bond and Goldstein 2015). In this context, this research is aimed to trace whether intervene in an open market economy or not. In addition to this, the research will discuss the stand of Australian government regarding current minimum wage to provide practical example of protectionism.

Government of trade participating countries often use price ceiling and price flooring as the mechanism of interventionist policy to protect market from failure. According to the economic theory, government use price floors on certain importable if it believes that goods or services are sold at an unfair market price (Baumol and Blinder 2015). It leads to reduction in the profit of the domestic firms and higher import leading to fall in Balance of Payment (BOP) (McCombie and Thirlwall 2016). Under successive reduction in BOP, market become prone to failure and government takes price floor mechanism to protect the market. Utilising the price flooring, government enhance the prevailing market price, leading to fall in demand and rise in surplus of the domestic producer.

Figure 1 depicts that if government go for price floor, then the market price of good or service will increase from PE to PC, leading to surplus production due to higher output generation of the domestic producer. This surplus output will effectively lead to fall in the price of the world market and thus saving domestic market from failure (Galbraith 2015).

Next to this, the report is focused to discuss the rational of price ceiling as government’s interventionist policy to protect market failure. According to the economic theory of price ceiling, it can be seen that government use price ceiling, when it believes certain good or service is being sold at higher price leading to fall in consumer surplus (Posner 2014). Under this condition government set a lower price to create a demand-supply gap in the market. Price being set at lower value compared to the existing market equilibrium, there will be shortage in supply of the said good or service and it will lead to higher consumer surplus considering that the demand curve is relatively elastic in nature (Friedman 2017).

Price Ceiling as Government's Interventionist Policy

From figure 2, it can be seen that equilibrium price is PE where the quantity demanded is QE. Now, if government goes for price ceiling, then it will lead to fall in price to PC. Price being lower than the equilibrium, there will be excess demand, however producer will produce less leading to a gap between quantity demanded and supplied (Mishan 2015). It will lead to fall in the producer surplus; however, there will be a rise in consumer surplus, because now they can have higher quantity of the said good or service at a lower price.

Vastness and magnitude of the international trade has attracted focus of many researchers since decade that has lead to plethora of researches on the rational of government’s intervention under the open market economy. Various researches has came up with differentiated view regarding the government’s interventionist policy like price flooring, price ceiling (Nugent 2017). Some researches argue that it is good to intervene the market by the government through policies like price ceiling and price flooring in order to save the market from breaking down; whereas some researches oppose this idea (Perkis et al. 2016). Below are the various views regarding the government’s interventionist policy like price ceiling and price flooring, which are being utilised for gauging the market breakdown.

Arguments for the government’s plan to intervene market are as follows (Nepal and Jamasb 2015):
  • Government’s policy like price ceiling and flooring constrains the monopoly power of the firms
  • Enhance the utility of the consumers
  • Reduce the scope of negative externality
  • Helps the firms to compete with the foreign traders

Arguments against the government’s plan to intervene market are as follows (Smith and Meier 2016):

  • Price ceiling and price flooring can lead to excess bureaucracy in market.
  • Price ceiling halts the growth of the infant industries and widens the supply-demand gap in labour market.
  • Government’s intervention through price ceiling and price flooring can lead to exploitation of labours who do not come under contract and can lead to black market.

Minimum wage law in Australia, established back in 2005 is one of the ambitious projects of the Australian government to mitigate the disparity in wage of different sectors (Buchanan and Oliver 2016). Through introduction of the Australian Far Pay Commission, Australian government tried to bring in parity in the minimum wage level throughout the different sectors (Mavromaras et al. 2015). Minimum wage law can be seen as the price ceiling where, government intervened market in order to boost the market through determining the price of labour across all the sectors. There has been various researches regarding this issue and they possess different view regarding the minimum wage law of Australia. According to the Manning (2016), with the introduction of minimum wage, government has reduced the employment rate of the country. Minimum wage has forced all the firms of Australia to pay predefined wage to every employee irrespective of their skill level. It has lead to higher operation cost for the firms and the firms are forced to shelf some amount of unskilled labour (Hirsch et al. 2015). In addition to this, reduction in the unskilled labour force has caused a rise in demand of skilled labours, which caused further rise in wage rate of the employees, thus leading the market far from equilibrium in the labour market.

Contrary to this, various researches has argued that through the implication of the minimum wage rate, government has aided the labour market to soar, through higher labour wage, labour supply is expected to rise (Leigh and Blakely 2016). However, through empirical analysis it has been found that price ceiling has lead to rise in wage rate exorbitantly in the western Australia that has lead to fall in employment due to lack of availability of skilled labour.

Arguments for and Against Government Intervention

Though the comparative analysis of Australian minimum wage, it can be seen that the country has highest minimum wage rate among all the countries who follow the price ceiling principle in labour market. In addition to this, comparative analysis has also showcased that though the participation rate of Australia has enhanced due to minimum wage law, however, overall employment has felt over the years (Evans 2016). So, if Australian government continues with its minimum wage law, then it will lead to a gap between demand and supply of labour, ultimately causing breaking down of the market economy.

Though this analysis it has been found that there are both positive and negative implication of the government’s protectionism act. However, according to the Gasper et al. (2016), considering the relative magnitude of positive and negative effect of the programs like price ceiling and price flooring it can be stated that, governments of respective countries need to rethink their stand. When it comes to Australian government, then it has been persuading minimum wage law since last few decades that has been hampering the employment level. However, it is also true that price ceiling has helped the government to raise percentage of skilled labour out of total labour force. Now, being the economic policy advisor to the government, some recommendations are provided below, keeping both the views of price ceiling and price flooring and minimum wage condition of Australia:

  1. It is true that no economic policy is possible without the involvement of active involvement of government. However, price ceiling and price flooring is aggressive interventionist policy from government. Thus government need to survey the market and implement it to only those places where it is necessary rather than making it general for every place in the specific economy.
  2. Considering the case of Australia it would be ideal to recommend that government need to liberalise the minimum wage policy so that small firms can grow to maturity stage otherwise it can bring in crippling blow to the country’s economy in future.
  3. Government of Australia can reduce the price ceiling in different region of the country depending upon the survey result to bring in parity in percentage change of wage rate, which will aid the infant industries to foster and stops the large industry to gain monopoly power.
  4. Product as well as labour market gets highly hampered in case of price ceiling and price flooring. Thus government need to trace out other ways to enhance the surplus of both the sector through reducing the deadweight loss perceived from the price ceiling and price flooring.
  5. On the positive side of price ceiling and price flooring, it can be seen that demand of the skilled labour has enhanced. Thus to mitigate the supply and demand gap in the labour gap, government need to introduce vocational training program and skill enhancement workshop.

Conclusion:

The report has been made to trace out whether governmental intervention in open market economy is required or not utilising the various economic theories and principle. The report has found that there is no economic model that neglects the governmental intervention as the market controlling authority. Governmental control under the open market, can lead to  deadweight loss and wide gap in demand and supply both in the product as well as labour market, yet it can enhance the economic aim of a country through producing skilful labours. From this analysis it has also been found that, Australian government’s stand to minimum wage is not valid from today’s perspective thus throughout the country. Thus it has been recommended that the government need to introduce surveys that will aid them to roll out differentiated price ceiling depending upon the region and its state of economy. to conclude it can be state that whether price ceiling or price flooring is good or bad, government need to intervene the market with economic policies to save it from failure irrespective of economic condition during short-run.

Reference:

Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Cengage Learning.

Bond, P. and Goldstein, I., 2015. Government intervention and information aggregation by prices. The Journal of Finance, 70(6), pp.2777-2812.

Buchanan, J. and Oliver, D., 2016. ‘Fair Work’and the Modernization of Australian Labour Standards: A Case of Institutional Plasticity Entrenching Deepening Wage Inequality. British Journal of Industrial Relations, 54(4), pp.790-814.

Evans, A., 2016. Thinking and Working Politically in the Global Garment Industry: Strengthening Trade Unions, Tackling Gender Ideologies and Reforming International Trade.

Friedman, M., 2017. Price theory. Routledge.

Galbraith, J.K., 2015. The new industrial state. Princeton University Press.

Gaspar, V., Obstfeld, M.M., Sahay, M.R. and Laxton, M.D., 2016. Macroeconomic Management When Policy Space is Constrained: The 3-C Approach to Economic Policy. International Monetary Fund.

Hirsch, B.T., Kaufman, B.E. and Zelenska, T., 2015. Minimum wage channels of adjustment. Industrial Relations: A Journal of Economy and Society, 54(2), pp.199-239.

Leigh, N.G. and Blakely, E.J., 2016. Planning local economic development: Theory and practice. Sage Publications.

Lim, C.R., Harris, K., Dawson, J., Beard, D.J., Fitzpatrick, R. and Price, A.J., 2015. Floor and ceiling effects in the OHS: an analysis of the NHS PROMs data set. BMJ open, 5(7), p.e007765.

Manning, A., 2016. The elusive employment effect of the minimum wage.

Mavromaras, K., Sloane, P. and Wei, Z., 2015. The scarring effects of unemployment, low pay and skills under-utilization in Australia compared. Applied economics, 47(23), pp.2413-2429.

McCombie, J. and Thirlwall, A.P., 2016. Economic growth and the balance-of-payments constraint. Springer.

Mishan, E.J., 2015. Elements of Cost-Benefit Analysis (Routledge Revivals). Routledge.

Nepal, R. and Jamasb, T., 2015. Caught between theory and practice: Government, market, and regulatory failure in electricity sector reforms. Economic Analysis and Policy, 46, pp.16-24.

Nugent, N., 2017. The government and politics of the European Union. Palgrave.

Perkis, D.F., Cason, T.N. and Tyner, W.E., 2016. An experimental investigation of hard and soft price ceilings in emissions permit markets. Environmental and Resource Economics, 63(4), pp.703-718.

Posner, R.A., 2014. Economic analysis of law. Wolters Kluwer Law & Business.

Rodrik, D., 2017. Straight Talk on Trade: Ideas for a Sane World Economy. Princeton University Press.

Smith, K.B. and Meier, K.J., 2016. The Case Against School Choice: Politics, Markets and Fools: Politics, Markets and Fools. Routledge.

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