Chapter 8: Public Policy Control

 

                                          Chapter 8: Public Policy Control         

Objective: To understand how governments influence and alter the natural behavior of demand and supply using various policy tools like price control, taxation, subsidies, and trade regulations.

 

Introduction

Markets often deviate from perfect equilibrium due to interventions aimed at promoting welfare, reducing volatility, or protecting domestic industries. Governments use tools such as price ceilings, price floors, subsidies, taxes, and trade restrictions to influence demand and supply behavior. These interventions shift or distort market curves and can result in either shortages or surpluses. This chapter explores these mechanisms with the help of equations, real-life cases, and data-based simulations.

 

1. Price Controls: Ceilings and Floors

Let us consider the following linear demand and supply functions:

·         Demand Function: Qd = 600 − 2P

·         Supply Function: Qs = 100 + 3P

Equilibrium Condition

To find the equilibrium price and quantity, we equate demand and supply:

 600 − 2P = 100 + 3P
 Solving, we get: 5P = 500, hence P = 100
Substitute into either function to get quantity:
 Q = 600 − 2(100) = 400

Therefore, the equilibrium price is ₹100 and the equilibrium quantity is 400 units.

Price Ceiling Example (Milk Price Control)

Suppose the government sets a price ceiling at ₹70, which is below the market equilibrium.

·         At this price:
 Qd = 600 − 2(70) = 460 units
 Qs = 100 + 3(70) = 310 units

·         This leads to a shortage of: 460 − 310 = 150 units

Price Floor Example (Minimum Support Price on Wheat)

If a price floor is imposed at ₹120, above the equilibrium price:

·         At this price:
 Qd = 600 − 2(120) = 360 units
 Qs = 100 + 3(120) = 460 units

·         This leads to a surplus of: 460 − 360 = 100 units

 

2. Effects of Taxes and Subsidies on Curves

Taxes and subsidies change the effective price faced by producers or consumers and shift the curves.

Producer Tax Example (Petrol)

If a tax of ₹20 is imposed per unit, the new effective supply function becomes:
 Qs = 100 + 3(P − 20)
This shifts the supply curve to the left because producers receive less per unit sold.

Consumer Subsidy Example (LPG Gas Cylinders)

If consumers receive a ₹30 subsidy, they effectively pay less. The new demand function becomes:
 Qd = 600 − 2(P − 30)
This shifts the demand curve to the right, increasing quantity demanded and market price.

 

3. Trade Policy: Import Duties and Export Bans

Trade restrictions also affect equilibrium.

Example: Sugar Export Ban (India, 2023)

India banned sugar exports to stabilize domestic supply and prevent price inflation. This increased domestic supply, effectively shifting the supply curve to the right, leading to lower domestic prices. However, it reduced farmer income and disincentivized production.

 

4. Budgetary Impact of Government Intervention

Fiscal implications are an important part of policy design.

If the government gives a ₹30 per unit subsidy on 10 crore LPG cylinders, the total expenditure is:
 ₹30 × 10,00,00,000 = ₹3,000 crore

While consumers benefit, this creates significant budgetary pressure on the government.

 

5. Real Policy Case Studies

 

Case Study 1: LPG Subsidy Scheme (India)

To promote clean energy, the government launched the Direct Benefit Transfer (DBT) for LPG.

·         Subsidy per cylinder: ₹30

·         New effective price = P − 30

·         Revised demand curve: Qd = 600 − 2(P − 30)

·         Result: Rightward shift in demand, increased LPG adoption

However, the fiscal burden rose to ₹37,209 crore in FY 2022–23, requiring rationing of subsidies and price reforms.

 

Case Study 2: Rent Control Act (Mumbai)

Under the Bombay Rent Control Act, rent was frozen at pre-1947 levels.

·         Demand stayed high

·         Supply became fixed (vertical or perfectly inelastic)

·         Market failure: Landlords avoided renting; informal black markets emerged

This distorted the housing market, creating artificial scarcity and substandard living conditions.

 

6. Simulation Table: Five Policy Scenarios

Scenario	Policy Tool	Affected Curve	Result
A. Fertilizer Subsidy	₹500/tonne subsidy	Supply curve shifts right	Price falls; usage rises
B. Onion Export Ban	Ban on foreign sales	Domestic supply ↑	Prices drop; farmer earnings fall
C. Toy Import Duty	40% import tax	Supply curve shifts left	Prices rise; domestic producers gain
D. Sugar Price Floor	Floor price at ₹34/kg	Surplus created	Government procurement rises
E. LPG Price Cap	₹450 per unit	Demand ↑, supply ↓	Shortage and fiscal burden occur

                                                  

Now is the graph showing the effect of a price ceiling on market equilibrium. The red dashed line represents a government-imposed price ceiling at ₹70, resulting in a shortage where quantity demanded exceeds quantity supplied. Let me know if you'd like this exported as an image file or embedded in your chapter layout

Conclusion

Public policy influences markets through curve manipulation. Key learnings include:

·         Price ceilings lead to shortages by increasing demand and reducing supply.

·         Price floors result in surpluses by encouraging supply but discouraging demand.

·         Subsidies boost demand (or supply) but increase fiscal burden.

·         Taxes discourage consumption or production and shift curves accordingly.

·         Trade restrictions can help stabilize internal markets but may hurt long-term competitiveness.

Understanding the equations and behavioral outcomes of these interventions is critical for policy design that balances economic efficiency with social objectives.