The objective of this essay is to analyse and discuss the potential effects of a minimum pricing strategy on the alcoholic beverage industry. It will focus on three main economic agents: consumers, producers and the government. In doing so, the essay will first provide a definition on minimum pricing and its purpose in the economy, before discussing the potential effects it will have on each agent according to economic theory.
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Finally, the economic theory covered will be applied to the Scottish alcohol market to analyse the extent to which such a pricing strategy is a benefit and/or a disadvantage to each economic agent.
Minimum pricing, also known as a price floor, is defined as a method of government (or other economic agent) intervention that aims to correct or lessen instances of market failure by setting the price above the equilibrium level. Figure 1 depicts a model market for a good (or service); at equilibrium, the quantity of the good being produced is qE units, and the market price is P.
If the government then intervenes by setting a minimum price above the equilibrium, the new market price will be associated with an increase from P to P. In theory [assuming ceteris paribus], the rise in price should create a market surplus meaning that the quantity of the good being demanded (qd) would be greater than the quantity being supplied (qs). The law of supply states that a rise in the price of a good/service will generally increase its suppliers incentives to produce (higher prices will allow suppliers to earn a profit), suggesting the increase in the quantity supplied from qE to qs. Meanwhile, the law of demand dictates that the rise in price should prevent some consumers from purchasing the good, leading to a contraction along the demand curve from q to qd.
This method of intervention is often used in instances where the equilibrium conditions of the market lead to a social [or economic] outcome that is less than desirable e.g. negative consumption externalities that arise from the overconsumption of demerit goods such as tobacco and alcohol (to be covered later), or in a price support scheme to protect producers incomes (Sloman et. al 2018:56) in markets prone to fluctuations in supply, such as the agricultural market. Hence price stabilisation is often used to help the government achieve one of their key macroeconomic objectives and serves as an example of how governments can intervene to prevent, correct or lessen market failure).
Imposing a minimum price on a good or service will have various effects on the community surplus (the sum of consumer surplus and producer surplus) as the consumption and production of a good can also impact unrelated third parties who are not directly involved in its consumption or production.
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