Price Mechanism

Lessons

Senior 4 · Economics

Price Mechanism

4 lessons

Lesson 4 of 4

Price controls: maximum and minimum prices

35 min

"Not exceeding 2,303 Frw per litre"

On 3 April 2026 the Rwanda Utilities Regulatory Authority (RURA) announced that, from 4 April 2026, the maximum retail price of petrol would be "not exceeding 2,303 Frw/L" and of diesel "not exceeding 2,205 Frw/L", including VAT, and that Kigali's public transport base fare would be Frw 59.28 per passenger per kilometre. RURA said the adjustments reflected international market trends "as well as Government measures to mitigate the impact of global price fluctuations". At the other end of the market, NAEB sets a minimum price that coffee buyers must pay farmers for their cherries: Frw 600 per kg in 2025. Both are price controls: the government, not the market, sets a limit on the price. This lesson shows what such limits do.

Definition

Price control: a legal limit set by the government on the price of a good or service.

Maximum price (price ceiling): the highest price at which a good may legally be sold. It has an effect only if it is set below the equilibrium price.

Minimum price (price floor): the lowest price at which a good may legally be sold. It has an effect only if it is set above the equilibrium price.

Black market: illegal trade at prices above a legal maximum (or below a legal minimum).

1. Maximum prices

Why governments set them: to keep essentials such as fuel, rent, medicines or basic food affordable; to protect consumers from monopoly pricing; and to slow inflation during a crisis.

Worked example 1: a maximum price on tomatoes (illustrative)

The tomato market has $Q_d = 1\,600 - 2P$ and $Q_{s} = - 200 + 4 P$ , with equilibrium at Frw 300 and 1,000 kg. The government sets a maximum price of Frw 200.

Q_d = 1\,600 - 2(200) = 1\,200 \qquad Q_s = -200 + 4(200) = 600

Shortage: $1\,200 - 600 = 600$ kg a day. Only 600 kg is actually traded: 400 kg less than without the control, so some buyers who would have paid Frw 300 now get nothing.

Black-market price: the highest price at which buyers would take the 600 kg available is found from demand: $600 = 1\,600 - 2P \Rightarrow P = \text{Frw } 500$ , well above the old free-market price of Frw 300.

Effects of an effective maximum price:

Shortages, because quantity demanded exceeds quantity supplied.
Queues and rationing by other means: first come first served, coupons, or sellers' favourites.
Black markets, where the good is resold above the legal price.
Lower quality and less after-sales service, as sellers cut costs.
Less investment and falling supply over time, since profits are squeezed.
A cost to the state if it closes the gap with subsidies or lower taxes so that supply does not fall.
Benefit to the buyers who do obtain the good at the low price.

2. Minimum prices

Why governments set them: to protect farmers' incomes and encourage production (NAEB's farm-gate price); to protect workers' wages (a minimum wage is a minimum price for labour); and to discourage consumption of demerit goods, such as alcohol, by keeping their price high.

Worked example 2: a minimum price on tomatoes (illustrative)

The government now sets a minimum price of Frw 400 in the same market.

Q_d = 1\,600 - 2(400) = 800 \qquad Q_s = -200 + 4(400) = 1\,400

Surplus: $1\,400 - 800 = 600$ kg a day. If the government buys the surplus to hold the price, it spends

400 \times 600 = \text{Frw } 240\,000 \text{ a day}

and must store, export, give away or destroy 600 kg of a perishable crop every day. Consumers pay Frw 100 more per kg and buy 200 kg less than at equilibrium.

Effects of an effective minimum price:

Surpluses, which the government may have to buy and store at a cost to taxpayers.
Waste, especially of perishable goods.
Higher prices for consumers, who buy less.
Inefficient producers are protected, and resources stay in an industry that the market would shrink.
Illegal sales below the floor by producers who cannot sell their surplus.
Unemployment, in the case of a minimum wage set above the market wage.
Benefit: stable, higher incomes for producers and workers who can still sell.

Worked example 3: when is a price control binding?

NAEB's coffee floor. In 2025 the minimum farm-gate price was Frw 600 per kg, but NAEB reports that farmers earned an average of Frw 900. Because the market price was above the floor, the floor did not bind: it had no effect on the price or the quantity that year. It acts as insurance, protecting farmers only in a year when the market price would fall below Frw 600.

RURA's fuel cap. A cap of Frw 2,303 per litre binds only if the price at which importers would otherwise sell is higher. Then, as in Worked example 1, a shortage would appear unless the gap is closed. RURA's statement that the April 2026 prices reflected "Government measures to mitigate the impact of global price fluctuations" shows the usual remedy: the government acts on costs (taxes, levies or support to importers) so that supply can continue at the capped price.

Public transport fares. At Kigali's base fare of Frw 59.28 per passenger per kilometre, the base charge for a 10 km trip would be $59.28 \times 10 = \text{Frw } 592.80$ ; RURA publishes the detailed fare for each route.

Warning

Where you draw the line decides everything. A maximum price drawn above equilibrium, or a minimum price drawn below it, has no effect at all, and earns no marks if you go on to describe shortages or surpluses. Check the position first: maximum below, minimum above.

Tip

"Ceiling below, shortage; floor above, surplus." Then measure the gap along the horizontal axis at the controlled price: that gap is the shortage or the surplus.

Important

Discuss. When world oil prices jump, should RURA cap pump prices, or let them rise? Weigh the benefit to motorists, bus passengers and food prices against the risks of shortages and the cost to the budget.

CrashCourse, "Price Controls, Subsidies, and the Risks of Good Intentions: Crash Course Economics #20". Watch for the shortages caused by price ceilings and the surpluses caused by price floors, and compare them with Worked examples 1 and 2.

✦

Practice

Distinguish between a maximum price and a minimum price, and say where each must be set to be effective.
Give three reasons why a government may set a maximum price.
Demand is $Q_{d} = 500 - 5 P$ and supply is $Q_{s} = 10 P - 100$ . Find the equilibrium. Calculate the shortage at a maximum price of 30, and the black-market price.
Using the same market, find the surplus at a minimum price of 50, and the cost to the government of buying it.
With a diagram, explain the effects of a minimum wage set above the equilibrium wage.
Explain why NAEB's farm-gate price of Frw 600 had no effect on coffee prices in 2025.
Explain four effects of a maximum price on fuel.
"Price controls do more harm than good." Discuss, with Rwandan examples.

Show answersHide answers

A maximum price is the highest legal price and must be below equilibrium to bind; a minimum price is the lowest legal price and must be above equilibrium to bind.
Any three: keep necessities affordable; protect consumers from monopoly; control inflation in a crisis; fairness to the poor.
$500 - 5P = 10P - 100 \Rightarrow P = 40,\ Q = 300$ . At 30: $Q_{d} = 350$ , $Q_{s} = 200$ : shortage 150. Black-market price: $200 = 500 - 5P \Rightarrow P = 60$ .
At 50: $Q_{d} = 250$ , $Q_{s} = 400$ : surplus 150; cost $50 \times 150 = 7\,500$ .
Wage on the vertical axis, labour on the horizontal; the minimum wage above equilibrium means more people want to work than firms want to hire: unemployment equal to the gap; those who keep jobs earn more.
The market price (an average of Frw 900) was above the floor, so the floor did not bind; buyers already had to pay more than Frw 600 to get cherries.
Any four: shortages and queues; black markets; less supply over time or lower quality; a cost to the budget if the government covers the gap; cheaper fuel for those who get it.
Harm: shortages, black markets, surpluses and costs to the state. Good: protect the poor (fuel, transport fares) and farmers (coffee floor), especially during shocks. A good answer concludes that controls work best as short-term or safety-net measures, backed by policies on costs and supply, rather than as permanent prices far from equilibrium.

Quick check

Key points

A maximum price binds only below equilibrium and causes shortages, queues, rationing and black markets.
A minimum price binds only above equilibrium and causes surpluses, which the state may have to buy, store or waste.
RURA caps fuel prices and sets transport fares; NAEB sets a coffee farm-gate floor, which did not bind in 2025.
Price controls help some buyers or sellers but create side effects; they work best with measures that act on costs and supply.

1"Not exceeding 2,303 Frw per litre"

21. Maximum prices

32. Minimum prices

"Not exceeding 2,303 Frw per litre"

1. Maximum prices

2. Minimum prices