Market Functioning: Definition, Operational Process
In the world of economics, the market mechanism plays a crucial role in determining the price and quantity of goods traded. This system, driven by the power of supply and demand, ensures efficient allocation of resources and helps in achieving market equilibrium. However, government intervention can disrupt this delicate balance.
A price floor is a legally imposed minimum price set above the market equilibrium price. This intervention, while aimed at protecting producers, can lead to economic inefficiencies. By raising the price, it creates excess supply, or surplus, as producers want to supply more at the higher price while consumers demand less. This surplus represents inefficient allocation because resources go to producing goods that are not fully absorbed by the market. For example, minimum wage laws can cause unemployment as labor supplied exceeds labor demanded.
Conversely, a price ceiling is a legally imposed maximum price set below the market equilibrium price. This intervention, intended to protect consumers, can also lead to economic inefficiencies. By lowering the market price, it causes excess demand, or shortage, as consumers want to buy more at the lower price, but producers supply less. This shortage leads to inefficiency as some consumers willing to pay more cannot purchase the good, and suppliers reduce production or withdraw from the market. This can also encourage black markets.
Both controls move the market away from equilibrium, generating deadweight loss, which represents lost gains from trade that neither consumers nor producers capture. The government-imposed price distortions reduce the market’s ability to allocate resources efficiently, resulting in wasted resources such as unsold goods or unmet consumer demand.
In a given example, a business produces 60 shirts and sets its price at Rp170,000, selling 10 shirts initially. In response to market demand, the business lowers the price to Rp130,000, selling an additional 50 shirts. This price adjustment brings the market closer to equilibrium.
While price floors and ceilings may seem like effective interventions, they often lead to misallocation of resources and reduce market efficiency. They are but two examples of government interventions that can disrupt the market mechanism. As we navigate the complexities of economics, it's essential to understand the implications of such interventions and strive for policies that promote market efficiency and resource allocation.
References: 1. Economics Online. (n.d.). Price Floors and Ceilings. Retrieved from https://www.economicsonline.co.uk/economics-topics/markets/market-intervention/price-floors-and-ceilings.html 2. Investopedia. (2021, March 17). Price Floor. Retrieved from https://www.investopedia.com/terms/p/pricefloor.asp 3. Investopedia. (2021, March 17). Price Ceiling. Retrieved from https://www.investopedia.com/terms/p/priceceiling.asp 4. The Balance Small Business. (2021, March 17). Deadweight Loss. Retrieved from https://www.thebalancesmb.com/deadweight-loss-2948365 5. The Balance Small Business. (2021, March 17). Market Equilibrium. Retrieved from https://www.thebalancesmb.com/market-equilibrium-2948361
Investing in the stock market requires careful consideration of various factors, including government interventions that can impact business operations. For instance, price floors and ceilings, commonly utilized to protect either producers or consumers, may lead to economic inefficiencies, resulting in wasted resources and reduced market efficiency. This is a crucial aspect of finance that every investor ought to understand when assessing potential investment opportunities in various businesses.
