Inquiry case example - Price controls in Venezuela

The planned economies of Eastern Europe used maximum prices

across the markets for many goods up until the late 1980s
when, one by one, they transitioned to market-based
economies. Hugo Chavez’s government in Venezuela, however,
brought in maximum prices on many necessity goods in 2003 to
try and support poorer households in the country. These
included price ceilings on cooking oil, white rice, sugar, coffee,
flour, margarine, pasta and cheese. These controls were
extended to other goods over the years.

The price controls went down badly with many businesses, especially when they are set below the
costs of production. A maximum price of 2.15 Bolivars was placed on a kilo of rice when the cost of
producing a kilo of rice was 4.41 Bolivars. Queueing became a daily part of life for Venezuela’s
consumers, who would spend long periods waiting in line for their daily shopping.

In 2013 there were incredible scenes when the army was called in by the state to manage an
electrical store the government believed was selling goods such as washing machines and televisions
at prices that were too high. Some of the managers were arrested for breaking the maximum price
regulations.

Questions
a. The diagram shows the impact of a maximum price (price ceiling) on the price of rice in
Venezuela.

(i) Outline a reason why the Venezuelan

government might have used a
maximum price on rice. [2]

(ii) Calculate the excess demand for rice

in Venezuela. [2]

(iii) Calculate the consumer surplus for

rice in Venezuela. [2]

(iv) Calculate the producer surplus for

rice in Venezuela. [2]

(v) Explain how the maximum price for rice in Venezuela changes the rationing function of price.
[4]

b. Explain the effects on consumers, producers, and the government of a maximum price (price
ceiling) introduced in the market for a good. [10 marks]

© Alex Smith
InThinking www.thinkib.net/Economics 1
c. Evaluate the effectiveness of a maximum price (price ceiling) as a way of making a good more
affordable to low-income households. [15]

Investigation
Research into goods and services which have been subject to maximum prices and discuss with
your class the consequences.

Responses:

Section a
(i) The Venezuelan government set a price ceiling for rice because they
want rice to become more affordable to low-income families
(ii) Excess demand = shortage = 22 - 9 = 13 million bags
(iii) Consumer surplus = Rectangle + small triangle = 9*(7.2-2.15) +
9*(7.79-7.20)/2 = 48.105
(iv) Producer surplus = Small upside down triangle = 9*(2.15-0.56)/2 =
7.155
(v) After the implementation of a price ceiling, the price for rice no longer
achieves its rationing function. Instead, non-price rationing methods will
be introduced in order to prioritize the demand for specialized
customers.

Section b
After a price ceiling is set, the producer faces a guaranteed loss, since
the product can only be sold at a lower price, it causes the producer to
produce the product at a smaller quantity, resulting the revenue to
shrink. The consumers partly gain and partly lose. The consumers that
are able to purchase the good at a lower price gain, and those who
weren’t able to buy the product because of shortage loses. The
unemployment rate rises, and there will be no effect on the government.

Section c
When the price ceiling of a good is set, at most of the times, it is
beneficial to low-income households, especially when the good is a
necessity. This will prevent heinous producers from overpricing their
products while consumers really need it at the same time, which will
generally make the low-income households better-off. Although the only
drawback is that this will create a shortage for the good, it is still better
than an unreasonable price that makes the good unobtainable for low-
income families.

© Alex Smith
InThinking www.thinkib.net/Economics 2