a) Explain how government control the prices using price ceiling and price floor.

Governments sometimes implement price controls, legal minimum or maximum prices for
specific goods or services, to attempt managing the economy by direct intervention. Price
controls can be price ceilings or price floors. A price ceiling is the legal maximum price for a
good or service, while a price floor is the legal minimum price. Although both a price ceiling and
a price floor can be imposed, the government usually only selects either a ceiling or a floor for
particular goods or services.

When prices are established by a free market, then there is a balance between supply and
demand. The quantity supplied at the market price equals the quantity demanded at that price.
So, the government imposition of price controls causes either excess supply or excess demand,
since the legal price often differs greatly from the market price. Indeed, the government imposes
price controls to solve a problem perceived to be created by the market price. A price ceiling
creates a shortage when the legal price is below the market equilibrium price, but has no effect
on the quantity supplied if the legal price is above the market price. A price ceiling below the
market price creates a shortage causing consumers to compete vigorously for the limited supply,
limited because the quantity supplied declines with price. Likewise, since supply is proportional
to price, a price floor creates excess supply if the legal price exceeds the market price. Suppliers
are willing to supply more at the price floor than the market wants at that price.
 The Consumer Affairs Authority in Sri Lanka imposed a maximum retail price for coconuts
with immediate effect. According to Extraordinary Gazette No.2194/73 the maximum retail price
of a single coconut with a circumference of over 13 inches will be fixed at Rs. 70/-, with
immediate effect. Further, the maximum retail price of a single coconut with a circumference
between 12 to 13 inches will be fixed at Rs. 65/- and a coconut with a circumference below 12
inches will be fixed at Rs. 60/-. The Extraordinary Gazette noted no producer, distributor or
trader shall sell, expose or offer for sale, or display for sale the item above the Maximum Retail
Price.
b) Briefly explain short term and long term effects of imposing price ceiling/maximum price

on Essential Goods.

A price ceiling is the mandated maximum amount a seller is allowed to charge for a product or
service. Usually set by law, price ceilings are typically applied only to staples such as food and
energy products when such goods become unaffordable to regular consumers

Price ceiling is practiced in an attempt to help consumers in purchasing necessary commodities

The disadvantage is that it will lead to lower supply. If firms get a lower price, there may be less
incentive to supply the good, and the number of properties on the market declines. A maximum
price will also lead to a shortage – where demand will exceed supply.

When the price ceiling is set below the existing market price, the market undergoes problem of
shortage. So it will affect to consumer needs & country economy. When price ceiling is set
below the market price, producers will begin to slow or stop their production process causing
less supply of commodity in the market. On the other hand, demand of the consumers for such
commodity increases with the fall in price. And with this imbalance between supply and demand
of the commodity, shortage is created in the market It will create long term affect to the country
economy.

If a ceiling is to be imposed for a long period of time, a government may need to ration the good
to ensure availability for the greatest number of consumers. One way the government may ration
the good is to issue ticket to consumers. A government will only allow as much of good to be out
in the marketplace as there are available tickets. To obtain the good, the consumer must present
the ticket and the money to the vendor when making the purchase. When there is extreme
shortage in the market, government begins rationing distribution to restrict the demand of the
consumers. As a result, consumers won’t be able to utilize as much goods as they need.
Government rationing also results in consumers needing to stay in queue for great deal of times,
and this can be troublesome to elderly, disabled and other people who cannot afford to stay in
line for a long time. This is generally considered a fair way to minimize the impact of a shortage
caused by a ceiling, but is generally reserved for times of war or severe economic distress.

A maximum price can lead to the emergence of black markets as people try to overcome the
shortage of the good and pay well above the market price.

Shortage of commodities encourages black market. Sellers begin trading commodities to

Not only that degradation of quality is another problem faced by consumers when imposing price
ceiling to essential foods. Producers try to cut off their cost and supply to inferior goods.
c). Discuss the challenges faced by Sri Lankan government when implementing price controls.

The implementation of price controls does not change the fundamental nature of the economic
problem. Decisions still need to be made about how to best allocate scarce resources among an
array of feasible alternatives. In the absence of price controls, these decisions are made through
the market process, which relies on true market prices reflecting the relative scarcity of
resources. However, with the implementation of controls, the market process is distorted and
political competition, at least partly, replaces market competition. Efforts are shifted from
pleasing private consumers to attempting to influence the political process, which ultimately
determines how controls are implemented and enforced. The result is that price controls attract
an array of political interests who seek to use controls for their own narrow pursuits at the
expense of the broader interests of private consumers.

When unemployment is especially high or when there is a shortage of goods, it can be difficult
for people to get what they need at an affordable price. The main appeal of government imposed
price controls is that they can ensure that citizens can purchase what they need in times of
national economic hardship.

Taxes are the primary means for governments to raise funds for its programs and to pay off its
debts. It can also be used to influence its citizens’ financial behavior. Choosing the right set of
rules that have all of the elements of a good tax system can be a challenge for any government.
When implementing price control system cause to decrease the income of government tax due to
the shortage of essential foods.

Not only that it will affect to reduce the income of foreign currency. When producers’ are not
producing enough goods, then export rate will be decrease. Due to lower level of exporting will
decrease income of foreign currency. Not only that government has to import essential foods
from other countries because of the shortage of foods. It will create additional expense for
government.
d) Explain the consequences of imposing a price ceiling for coconut using a diagram where
necessary. (You are required to take the prices prior to price ceiling as Rs. 80 and Rs. 65 for
large size and small size nuts respectively.)

Y-Values
120

100 100
90
80 80
70
60 60

40

20

0
0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5
References

(https://thismatter.com/economics/price-controls.htm, n.d.)
(https://www.investopedia.com/terms/p/price-ceiling.asp#:~:text=A%20price%20ceiling%20is
%20a%20type%20of%20price,shortages%2C%20extra%20charges%2C%20or%20lower
%20quality%20of%20products., n.d.) (https://www.newsfirst.lk/2020/09/25/maximum-retail-
price-imposed-for-coconuts-with-immediate-effect/, n.d.)

(https://www.businesstopia.net/economics/micro/effects-price-ceiling-and-price-floor#:~:text=Price
%20ceiling%20is%20practiced%20in%20an%20attempt%20to,market%20inefficiencies.%20Some
%20effects%20of%20price%20ceiling%20are, n.d.)

(Ratnasabpathy, 2018)