What is a Price Ceiling?

//What is a Price Ceiling?
What is a Price Ceiling? 2017-10-09T06:05:04+00:00

Definition: A price ceiling is the highest price a supplier is allowed to set for a product or service. Price ceilings are normally government-imposed to protect consumers from swift price increases in basic commodities.

What Does Price Ceiling Mean?

A price ceiling puts a limitation on the pricing system of sellers aiming to guarantee fair business practices. Such a government intervention is typically appropriate during periods of abnormal economic activity like wars, natural disasters and so on. During such periods, the supply of certain basic commodities is reduced, resulting in skyrocketing prices that consumers cannot afford. In other cases, the government intervenes to sustain some product prices or production rates at higher levels that those set by the market, so that producers’ income is protected.

On the other hand, price ceilings come with supply shortages and market inefficiencies. They may also force suppliers to create a black market for certain products.

Let’s look at an example.

Example

We assume that the equilibrium price is $25 per unit for a certain good. If the government sets a price ceiling of $15 per unit for this good, the quantity demanded will be 3,500 units, whereas the quantity supply will be 1,500 units. In this case, there is a supply shortage equal to 2,000 units for this particular product. Consequently, some consumers will not be able to buy the quantities they want. If the government does not intervene to achieve a fair distribution of the quantity supplied (something extremely difficult in practice), the suppliers may create a black market to sell the product at an extremely higher price than both the equilibrium price and the price ceiling.

We assume that the government imposes rent control setting a price ceiling at $1,500 for a one-bedroom apartment. If the city is not that popular, the landlords will face a demand shortage because fewer renters will be interested in renting an apartment. If the city is more touristic and popular, the landlords will rent all the apartments and there will be a supply shortage. In addition, the price may skyrocket to $2,500, ignoring the price ceiling, yet leaving the landlords with $1,000 per apartment as a waste of market demand.