APPLIED ECONOMICS

3RD QUARTER – WEEK 4

Learning Activity Sheet
Lesson 4.1: Government Intervention in Market Prices: Price Ceiling

Previously, we discussed the causes of disequilibrium which are the market

shortage and surplus. It happens because of the interaction of consumers and
producers about the prices, and the existence of scarcity. Since our country runs a
mixed economy, the government has a big role in attaining economic goals. Price
stability is one of the goals that the government must achieve. When prices are stable
in the market, both consumers and businesses enjoy their economic security.
Government intervention is needed to ensure that market prices are stable. This
module will give you a better understanding of the roles of the government in market
prices specifically in price ceiling.

Price Controls
The supply and demand model shows how people and firms will react to the
incentives that laws provide to control prices, in ways that will often lead to
undesirable consequences. Many Filipinos are complaining about the high prices of
commodities. Of course, they can’t afford to buy their needs at higher prices. With
this, the government intervene in the market prices to augment the social benefit of
the people through price controls. Price controls are government-mandated legal
minimum or maximum prices set for specified goods, most necessities. It is considered
as a government policy to stabilize the market prices for the benefit of consumers.
However, there are consequences of imposing these price controls. One of the price
controls that the government may adopt is the price ceiling.

Price Ceiling
Price ceiling is the maximum price that sellers need to impose on a certain
product. It is located below the equilibrium price as shown in figure 1.

It shows that the market demand and supply of sandwiches with an

equilibrium price of ₱20. Let say the government forced to have a price ceiling in
snacks and related products at ₱15, hence it is illegal to put higher prices above ₱15.
With a price ceiling of ₱15, quantity demanded increases from 60 to 80 sandwiches
while quantity supplied drops from 60 to 40 sandwiches. What will happen
eventually? This will cause shortage since the suppliers are discouraged to produce
more sandwiches with a lower price. Meanwhile, the consumers are willing to
purchase more sandwiches at a lower price.
In the Philippines, we have a government policy on rent control under Republic Act
No. 9653. The act focuses on the regulation of rent of certain residential units. Section
5 of the article states that:
“All residential units in the National Capital Region and other highly urbanized
cities, the total monthly rent for each of which ranges from One peso (P1.00) to
Ten thousand pesos (P10,000.00) and all residential units in all other areas, the
total
 monthly rent for each of which ranges from One peso (P1.00) to Five thousand
pesos (P5,000.00)…”
Meaning to say, the government sets the price ceiling on the monthly rent for
residential units in Metro Manila which is at a maximum of ₱10,000 for highly
urbanized areas (business center in Makati, Ortigas, Eastwood, etc.) and ₱5,000 in
other areas. Of course, everyone needs an affordable place to live. Perhaps
locallybased businesses expand, bringing higher incomes and more people into the
area. Changes of this sort can cause a change in the demand for rental housing.

Hypothetical Application of Price Ceiling:

The graph below shows the original supply and demand curves, S and D. You
can see the original equilibrium point, ₱4,000, and 6,000 units.

What do you think will be the effect of greater income or an increase in the
preferences living in Metro Manila? An increase in the preferences living in Metro
Manila would cause an increase in demand, causing the demand curve to shift to the
right from D1 to D2. The new equilibrium point is ₱5,000 and 8,000 units.

Let say, the price ceiling is set at ₱4,000 by the government as shown on the
graph by the horizontal dotted line. What is the new quantity demanded? The new
quantity demanded is the quantity at the point at which the new demand curve and
the price ceiling intersect, in the graph it is at 10,000 units.

With the price ceiling in effect, the quantity supplied remains at the same 6,000
rental units, but the quantity demanded increases to 10,000 rental units. In other
words, the quantity demanded exceeds the quantity supplied, so there is a shortage of
rental housing. This shortage is shown on the graph as the difference between the two
vertical lines (10,000 units - 6,000 units) which is 4,000 units.
 In the graphs above, we saw what happens when a price ceiling for the rent is
imposed to keep the price at the original equilibrium of ₱4,000 for a typical apartment.
The horizontal line at the price of ₱4,000 shows the legally fixed maximum price set.
At that price (₱4,000), the quantity supplied remains at the same 6,000 rental units,
but the quantity demanded is 10,000 rental units.

One of the ironies of price ceilings is that while the price ceiling was intended to
help renters, there are fewer apartments rented out under the price ceiling (6,000
rental units) than would be the case at the market rent of ₱5,000 (8,000 rental units).
When a price ceiling is set below the equilibrium price, as in this example, it is
considered a binding price ceiling, thereby resulting in a shortage.

Price ceilings or suggested retail prices have been proposed for basic
commodities like rice, cooking oil, medicines, and other necessities. Temporary price
ceilings are evident during a state of emergencies and calamities.

Lesson 4.2: Government Intervention in Market Prices: Price Floor

Price Floor
A price floor is the lowest legal price in which a commodity can be sold. Price
floors are used by the government to prevent prices from being “too low”. For a price
floor to be effective, it must be set above the equilibrium price. If it's not above
equilibrium, then the market won't sell below equilibrium and the price floor will be
irrelevant. To make the discussion clearer, let us use the market demand and supply
of sandwiches.

Figure 1 shows that the market demand and supply of sandwiches with an
equilibrium price of ₱20. Let say the government imposed a price floor in snacks and
related products at ₱25, hence it is illegal to put lower prices below ₱25. With a price
floor of ₱25, the quantity demanded decreases from 60 to 40 sandwiches while
quantity supplied increases from 60 to 80 sandwiches. What will happen eventually?
This will cause a temporary surplus of 40 sandwiches (80-40) since the suppliers are
encouraged to produce more sandwiches. In this scenario, we have applied the
demand and supply model to the product market. However, the most common price
floor is the minimum wage - the minimum price that a worker receives. Hence, we will
apply the model to the labor market. The price is the price of labor which is the wage,
and the quantity is the number of workers.

In the Philippines, we have specific minimum wage rates in different regions,

areas, and sectors. According to the National Wages and Productivity Commission
(NWPC), the highest daily wage rate per day is the National Capital Region with a
minimum wage rate ranging from ₱500 to ₱537. It is illegal to pay the employees below
the prescribed minimum wage rate. Most high-skilled and experienced workers earn
wages that are higher than minimum. Their employment opportunities are not much
affected by the minimum wage rate policy. Unlike highskilled workers, low-skilled and
inexperienced workers whose market-determined wages are lower than the minimum
wage will be affected.
Hypothetical Application of Price Floor:
The price floors are sometimes called “price supports,” because they support
the price by preventing it from falling below a certain level.

Figure 2 illustrates the effect of minimum wage on the market for unskilled
workers. Take note that on the demand side, this pertains to the number of workers
that the businesses or employers want to hire at various wage rates. Ceteris paribus,
as a wage rate decreases, the quantity demanded for workers increases, vice versa.
While on the supply of labor, this refers to the number of workers who want to be
hired at various wage rates. Law of supply says that, as wage rate increases, the
number of workers who are willing to be hired also increases.

Suppose the government releases a new policy regarding the minimum wage
rate at ₱600. Remember that price floor is always set above the equilibrium point. This
policy would make low-income workers better-off with a high income.

At the equilibrium wage, ₱500, there are 600 available workers to be employed.
Meaning, labor supply and labor demand meet at the equilibrium wage. At the
minimum wage rate of ₱600, 800 workers are available for hire, but only 400 workers
were employed. There are surplus or excess in supply of 400 workers (800400).

The effects of the minimum wage on the market for unskilled workers are:
1. a decrease in the employment of unskilled workers from 600 to 400; and
2. a surplus of unskilled workers equal to 400 (800-400).

With this, employers have more incentives to substitute machines and high-
skilled workers for low-skilled workers.

Lesson 4.3: Elasticities of Demand and Supply

Degrees of Elasticity

The coefficient of elasticity is the number obtained when the percentage change
in demand or supply is divided by the percentage change in the determinant. To
determine the responsiveness of consumers and producers to a change in an economic
factor, we have to compute the coefficient of elasticity and analyze its value. The
computed coefficient sets the degree of responsiveness and can be analyzed through
the classifications of elasticity.
1. Elastic – a change in a determinant will lead to a proportionately greater
change in demand or supply. The absolute value of the coefficient of elasticity is
greater than one (1). For example, the price of milk tea increases by 10%, and as
result the quantity demanded goes down by 15%, then we can say that the demand for
milk tea is elastic. Elastic goods are often described as non-essentials.
2. Inelastic – a change in determinant will lead to a proportionately lesser
change in demand or supply. The absolute value of the coefficient of elasticity is less
than one (1). For example, the price of yellow paper goes up by 5% and the quantity
demanded goes down by 4%, then we can say that the demand for yellow paper is
inelastic. Inelastic goods are often described as necessities.
 3. Unitary Elastic – a change in determinants will lead to a proportionately
equal to a change in demand or supply. The absolute value of the coefficient of
elasticity is equal to one (1). Let us say that the price of school uniform goes down by
6% and as a result, the quantity demanded goes up by 6% also, we describe the
demand for school uniform as unitary elastic.

Elasticity of Demand

Three types of elasticity of demand deal with the responses to a change in the
price of the goods, in income, and in the price of related goods – substitute or
complementary.

1. Price Elasticity of Demand

This measures the responsiveness of demand to a change in the price of the
good. One of the measures of the price elasticity of demand is arc elasticity. The value
of arc elasticity is computed by choosing two points on the demand curve and
comparing the percentage changes in the quantity and the price on those two points.
We can compute the coefficient using the following formula

The computed coefficient is normally has a negative value. It signifies the

inverse relationship of the quantity demanded and the price. Hence, we need to take
the absolute value of the coefficient to reflect its degree of responsiveness. When the
price is greater than 1, it implies that the demand is elastic since the percentage of
change in the quantity demand is greater than the percentage change in the price. We
can say that the good is non-essential to consumers.

Example: Kevin used to buy snacks outside the school during dismissal. He munched
15 burgers for ₱20. After a month, the price of burgers rose to ₱25 due to the increase in
the price of LPG. Right now, Kevin can consume 5 burgers.

Analysis and explanation:

The value of price elasticity of demand is 4.5. This means that the change in the
quantity demanded is greater than the change in the price and higher than 1.
Therefore for Kevin, the burger is elastic or non-essential good.

2. Income Elasticity of Demand

This measures how the quantity demanded changes as consumer income
changes. Income Elasticity of Demand is equal to [percentage change in quantity
demanded] / [percentage change in income]. A positive (+) coefficient implies that the
good demanded is normal good while a negative (-) coefficient implies inferior good.
3. Cross Price Elasticity of Demand
This measures how the quantity demanded changes as the price of a related
good change. Cross Price Elasticity of Demand measures the responses of the demand
for a good to change in the price of a substitute good or a complement. A positive (+)
coefficient means the two goods involved are substitute goods, meaning to say, as the
price of the substitute good increases, the demand for the other good will increase.
The negative (-) coefficient indicates that the two goods are complementary, meaning,
the demand for a good will increase when the price of a complement decreases.

Elasticity of Supply
The price elasticity of supply is the measure of the responsiveness in quantity
supplied to a change in price for a specific good. Numerous factors directly impact the
elasticity of supply for a good including stock, time, availability of substitutes, and
cost of production. The state of these factors for a particular good will determine if the
price elasticity of supply is elastic or inelastic in regard to a change in price.

ACTIVITIES
I. Directions: Read each statement carefully. Write T if the statement is correct,
otherwise write F.
____________1. In price ceiling, it is illegal to charge prices higher than the equilibrium
price.
____________2. Price ceiling is a legal maximum price for a product.
____________3. Price ceiling is located above the equilibrium price.
____________4. The result of the price ceiling is shortage.
____________5. There is always new equilibrium as the government sets prices.

II. Directions: Read each statement carefully. Write T if the statement is correct,
otherwise write F.

____________1. A price floor is inefficient because resources are over-allocated to

produce an item in a quantity greater than what consumers are demanding.
____________2. Price floor is a legal maximum price for a product.
____________3. Price floor is located above the equilibrium price.
____________4. The result of price ceiling is surplus.
____________5. The government has the power to control the prices in the market.
III. Directions: Read each statement carefully. Write T if the statement is correct,
otherwise write F.

____________1. The cross elasticity of demand is an economic concept that measures

the responsiveness in the quantity demanded of one good when the price for other
good changes.
____________2. The price elasticity of demand is the measure of the responsiveness in
quantity supplied to a change in price for a specific good.
____________3. Price elasticity of demand that is less than 1 is inelastic.
____________4. The formula to get the price elasticity of supply the percentage of
change in the quantity in supply divided by the percentage change in price.
____________5. A positive sign for income elasticity means that the good demanded is
an inferior good.

Published by the Department of Education - Schools Division of Pasig City

Development Team of the Self-Learning Module

Writer: Emmanuel B. Penetrante

Editor: Hedelita B. Calonia
Reviewers:
Content/Language: Hedelita B. Calonia
Technical: Emmanuel B. Penetrante
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