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Micro Economics

Notes A price floor exists when the price is artificially held above the equilibrium price and is not

allowed to fall. There are many examples of price floors. In some cases, private businesses

maintain the price floor while, in other cases, it is the government that maintains the price fl oor.

One price floor that was maintained by the private businesses used to be called “fair trade”.
In the case of fair trade, the manufacturer would set a price for the product that was above the
equilibrium price. The manufacturer then told the retail stores that the price could not be lowered
or the store would not be able to sell any of the manufacturer’s products.
When a “price floor” is set, a certain minimum amount must be paid for a good or service. If the

price floor is below a market price, no direct effect occurs. If the market price is lower than the
price floor, then a surplus will be generated. Minimum wage laws are good examples of price

fl oors.

Task Give examples from real life situations, where a price ceiling or price fl oor has
been imposed.

Case Study Demand – Supply and Price of Gold
ast month saw more housewives in the jewellery shops than in any month in the
past. There were no big festivals, neither too many marriages. What attracted them
Lwas the fall in the price of gold. That was so the world over.
Gold prices have been falling for nearly a decade now. Last week they had drifted to their
lowest in the past 18 years. The highest price in the world market was reached in 1980
when it touched $850 an ounce, almost three times the present price. Indian buyers did not
experience the full impact because of the restrictions on import of gold. These have been

significantly eliminated and the price behaviour in the domestic market now conforms to
the international price.
The fall in the price of gold has more to do with the change in demand. Gold has many
uses, Jewellery is only of them. It is an industrial metal, a form of saving for the rainy day
and an international reserve asset for most central banks. The lure of gold for ornaments
remains almost in tact. But as a form of saving or as reserve for the central banks, gold is
no longer attractive. It is precisely this loss in trust that has caused the fall in the price of
gold.

Gold has become a bad investment. Anyone would weigh an asset in terms of the return it
earns, the security it gives and the ready market it enjoys. The last is the best with gold. But
with the price going down; investment in gold makes no sense. An investment of ` 1,000
in gold in India in 1990 would have fetched today ` 1,120. That gives a yield of less than 3
per cent. Not worth the game.

The same investment in equity would have matured into ` 1,900 and in bank deposit
` 2,200. Gold is no longer a viable investment though the housewife may still buy gold
partly for display and partly from ignorance about the alternative opportunities.

The penchant for jewellery is much more in India and West Asia than in most other countries.
The world demand for jewellery was 2,807 tonnes last year. Gold that was actually mined
was only 1,350 tonnes. The balance came from sales by the central banks. The bankers are

Contd...

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