On a normal goods market, supply and demand find an equilibrium, where, for
the equilibrium price, the quantity demanded is being supplied. However, it can
happen that the state is forced to intervene in this mechanism of price formation
for social- or economic- policy reasons. Maximum and minimum prices can be
used by the state as an instrument for this purpose. Which of the two instruments
is chosen depends on whether the state wants to improve the situation of
suppliers or consumers. By intervening in the market like this, the state
attempts to prevent the market equilibrium of supply and demand from being
First, the betterment or protection of consumers, i.e. the introduction of a maximum price, will be analyzed.
In order to avoid a too high price, e.g. for rent or staple foods, the state can set a maximum price that is lower than the equilibrium price. Thus, the consumer pays a lower price for the demanded good.
The figure above shows the effect of a maximum price. The market is in equilibrium at and . The maximum price leads to a supply of goods of and to a demand for goods of . Since there is now more demand than supply, there is an excess demand in the amount of the difference between the and .
A maximum price leads to a reduction in production and to an increase in the quantity demanded. The regulations of the maximum price prevent the price to rise above the equilibrium.
The level of the maximum price can be as far below the equilibrium price as desired. The further below the equilibrium price the maximum price lies, the greater the excess demand. In reality, unsatisfied demand seeks a valve. Typically, black- or barter- markets are created, additional services are requested, or the corresponding good can only be obtained through relationships.
The consumer surplus of the consumers remaining in the market increases at the expense of the remaining producers and the consumers and producers leaving the market.