Price Ceiling

Posted by Professor Cram in Government Intervention

Definition of Price Ceiling

A Price Ceiling is a government-imposed maximum price for a product.

Impact of Government Imposed Price Ceiling that is above the equilibrium price

Supply and Demand Curve

Supply and Demand Curve

When a price ceiling imposed by a government is higher than the market equilibrium price, the price ceiling has no impact on the economy. It does not restrict supply nor encourage demand. It says you cannot charge (or be charged) more than an amount that is higher than is already being charged.

Graph A in the previous section, shows the equilibrium price of $5 for a product determined by the intersection of the supply and demand curves.

Equilibrium price is the price at which the quantity demanded is equal to the quantity supplied. Typically, market forces do not move to change either demand or supply at the equilibrium price.

If a government mandated price ceiling of $100 were imposed, nobody would notice, since the ceiling is so far above the market price. If the price ceiling were $5.01 it wouldn’t have an immediate effect, but the first time market forces change to increase the equilibrium price, the ceiling would no longer be below below the market price, and it’s impact would begin to be felt. [See section below on impact when price ceiling is below equilibrium price.]

Impact of Government Imposed Price Ceiling that is below the equilibrium price

A price ceiling can either be above or below the equilibrium price, as shown by the dashed and solid lines in Graph B.

Price Ceiling

Price Ceiling

The dashed line of Graph B represents the government’s imposed maximum price (ceiling price) above the market-determined equilibrium price, and has no measurable affect on the product’s price. In this case, the market is unable to produce a price as high as the ceiling price.

A different effect occurs when the government’s imposed maximum price is below the market’s equilibrium price, as shown by the solid line in Graph B. Suppliers can no longer charge the price the market demands but are forced to meet the maximum price set by the government’s price ceiling.

A low ceiling price can drive suppliers out of the market (reducing the supplied resources), while the lower price drives increased consumer demand. When the demand increases beyond the ability to supply, shortages occur. This creates a rationing of the product by the market. Some consumers could experience longer lines for the product or no available products when they need or desire to purchase. Sometimes governments combine low price ceilings with government rationing programs that mandate how the market will allocate the now inadequate supply of goods.

Price Ceiling compared to a Price Floor

A Price Ceiling is a government-imposed maximum price charged on a product. It differs from a price floor in that a price ceiling artificially keeps prices from rising too high, which in theory allows consumers to afford the product or service, but can result in shortages and rationing. A price floor keeps prices from falling too low, which can protect producers, but can generate excess supply and waste.

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