Worked example 3 — A price ceiling and a price floor, worked on the two curves

A great deal of Indian economic legislation fixes a price. Rent control fixes a maximum; the minimum support price for a crop and the statutory minimum wage fix minimums. Litigation about such statutes asks whether the fixed price leaves the producer a reasonable return — and to argue that at all you must be able to show, arithmetically, what a fixed price does. This example does it.

Demand. Other things being equal, the demand for a good increases with a decrease in price and decreases with an increase in price. The phrase other things being equal means the prices of related goods, the income of consumers and their tastes and preferences all remain constant.

Supply. In Dooley's words, other things remaining the same, the higher the prices the greater the quantity supplied and the lower the prices the smaller the quantity supplied. Its assumptions: the incomes of buyers and sellers constant, tastes and preferences constant, the cost of all factors of production constant, technology constant, the commodity divisible, and the law stating only a static situation.

Why supply slopes upward. Sellers become ready to offer more from their old stocks; producers increase production in view of higher profit possibilities; and new firms enter the market seeing higher profit, which in turn increases supply.

Put a demand schedule and a supply schedule side by side. Only one price makes the two quantities equal; that is the equilibrium price, and the quantity traded there is the equilibrium quantity. It is where the two curves cross.

An illustrative pair of schedules, built so that the numbers are easy to follow:

| Price (Rs.) | Quantity demanded | Quantity supplied | Gap | |---|---|---|---| | 10 | 100 | 20 | shortage of 80 | | 20 | 80 | 40 | shortage of 40 | | 30 | 60 | 60 | equilibrium | | 40 | 40 | 80 | surplus of 40 | | 50 | 20 | 100 | surplus of 80 |

The mechanism that drives the price to Rs. 30 is competition on the short side. At a high price, buyers want little and sellers offer much: there is a surplus, and sellers competing to clear it push the price down. At a low price, buyers want much and sellers offer little: there is a shortage, and buyers competing for the scarce goods push the price up.

Suppose a statute or an order fixes a maximum of Rs. 20.

• Quantity demanded at Rs. 20: 80.
• Quantity supplied at Rs. 20: 40.
• Excess demand: 40 units, every period, indefinitely.

The shortage that follows is not an accident of administration but an arithmetical consequence of the two laws. Forty units of demand have to be disposed of somehow, and there are only three ways: rationing (the State decides who gets the 40 units), queues (time replaces money as the price), and a black market (the price is paid anyway, illegally, and the premium is captured by whoever controls the supply).

That is why statutes fixing a maximum price almost always carry allocation and anti-hoarding machinery alongside the price provision. The machinery is not an afterthought; it is the only way to distribute a shortage the price provision itself creates.

The second-round effect a good answer adds. The supply schedule is drawn for the short period. Over time, at Rs. 20, some sellers exit, no new firms enter, and the supply curve shifts left — so the shortage widens the longer the ceiling holds. This is why the economic argument in rent-control litigation is not that the tenant gains nothing, but that the stock of lettable housing shrinks.

Now suppose a minimum of Rs. 40 is announced — a price floor, as with a minimum support price for a crop or a statutory minimum wage.

• Quantity demanded at Rs. 40: 40.
• Quantity supplied at Rs. 40: 80.
• Excess supply: 40 units.

The surplus must be bought up, stored or absorbed by someone. That is not a criticism of price support; it is a description of what price support necessarily entails. If the State announces a floor and does not procure, the floor is a dead letter, because at Rs. 40 only 40 units find a buyer and the other 40 either rot or are sold below the floor.

India has a product price support system in the form of minimum support prices announced by the Government for different commodities, based on the recommendations of the Commission for Agricultural Costs and Prices. Since 2018-19 the basis has been fixed: the decision to fix the MSP at 1.5 times the all-India weighted average cost of production is, in the Economic Survey's assessment, an important step that provides greater price certainty and assures farmers of a specified return.

Now trace the consequence through the syllabus, because this is the chain examiners reward:

1. The MSP is a floor above the market-clearing price — otherwise it would be pointless.
2. A floor above the clearing price generates a surplus (step 4).
3. The surplus is procured — the Government procures wheat, rice and coarse grains from farmers at the mandis.
4. Procurement generates stocks, which must be moved and stored in warehouses.
5. The stocks are what the National Food Security Act 2013 distributes, through the network of Fair Price Shops, to a coverage of up to 75 per cent of the rural and up to 50 per cent of the urban population — around 81.35 crore beneficiaries on 2011 Census figures.
6. To stabilise prices when stocks are excessive, the Government undertakes measures such as the Open Market Sale of staple foodgrains.

Price support and food security are therefore not two topics but two ends of one system, and the arithmetic in step 4 is the hinge between them.

A floor that generates 40 surplus units costs the State the price of those units, plus movement, plus storage, plus wastage. Every one of those is public expenditure in the sense of Module 3, and subsidies are named there among the components of revenue expenditure — the least discretionary component, because subsidies are politically very hard to withdraw. The fiscal weight of the food subsidy is the direct arithmetic consequence of the price floor, and an answer that says so has connected Module 1 to Module 3 in one sentence.

The lawyer's question is not whether the shortage or surplus exists — it does, by arithmetic — but whether the fixed price is lawful. Two propositions from this course frame that.

First, courts examine whether a fixed price leaves the producer a reasonable return. That is a question about where the fixed price sits relative to cost, which is exactly what the 1.5-times-cost formula is designed to answer in advance for crops.

Second, on trade and fiscal policy generally, the courts allow the executive free play. In P. T. R. Exports (Madras) Pvt. Ltd. v. Union of India the Supreme Court held that the Court would prefer to allow free play to the Government to evolve fiscal policy in the public interest and to act upon the same, and that the Government is left free to determine priorities in matters of allocation and utilisation of its finances in the public interest. Challenges to a price order on the merits therefore rarely succeed; the arguments that succeed are procedural.

The demand and supply schedules in step 2 are illustrative arithmetic constructed for this example. Do not quote them as data. The Indian material used here — the MSP formula, the CACP, procurement, Fair Price Shops, NFSA coverage, Open Market Sale — is sourced and may be quoted.

1. Equilibrium is where the curves cross; competition on the short side drives the price there.
2. A ceiling below equilibrium creates a shortage — hence rationing, queues, black markets, and allocation and anti-hoarding machinery in the statute.
3. A floor above equilibrium creates a surplus — which someone must buy, store or absorb.
4. India's floor is the MSP, on CACP recommendation, at 1.5 times the all-India weighted average cost of production since 2018-19; the surplus it creates is procured, stored and distributed under the NFSA, with Open Market Sale to stabilise prices.
5. A shift moves the equilibrium: an increase in demand raises price and quantity; an increase in supply lowers price and raises quantity. Any claim that a statute or a cartel raised prices must say which curve moved.