A
price ceiling is a government-imposed limit on the price charged for a product. Governments intend price ceilings to protect consumers from conditions that could make necessary commodities unattainable. However, a price ceiling can cause problems if imposed for a long period without controlled rationing. Price ceilings can produce negative results when the correct solution would have been to increase supply. Misuse occurs when a government misdiagnoses a price as too high when the real problem is that the
supplyIn economics, supply is the amount of some product producers are willing and able to sell at a given price all other factors being held constant. Usually, supply is plotted as a supply curve showing the relationship of price to the amount of product businesses are willing to sell.In economics the...
is too low. In an unregulated
market economyA market economy is an economy in which the prices of goods and services are determined in a free price system. This is often contrasted with a state-directed or planned economy. Market economies can range from hypothetically pure laissez-faire variants to an assortment of real-world mixed...
price ceilings do not exist. Students may incorrectly perceive a price ceiling as being on top of a supply and demand curve when in fact, an effective price ceiling is positioned below the equilibrium position on the graph.
Binding Versus Non-Binding price ceilings
A price ceiling can be set above or below the free-market equilibrium price. For a price ceiling to be effective, it must differ from the free market price. In the graph at right, the supply and demand curves intersect to determine the free-market quantity and price. The dashed line represents a price ceiling set above the free-market price, called a
non-binding price ceiling. In this case, the ceiling has no practical effect. The government has mandated a maximum price, but the market price is established well below that. In contrast, the solid green line is a price ceiling set below the free market price, called a
binding price ceiling. In this case, the price ceiling has a measurable impact on the market.
Consequences of Binding Price Ceilings
A price ceiling set below the free-market price has several effects. Suppliers find they can't charge what they had been. As a result, some suppliers drop out of the market. This reduces supply. Meanwhile, consumers find they can now buy the product for less, so quantity demanded increases. These two actions cause quantity demanded to exceed quantity supplied, which causes a shortage—unless rationing or other consumption controls are enforced. It can also lead to various forms of non-price competition so supply can meet demand.
Reduction in quality
To supply demand at the legal price, the most obvious approach is to lower costs. However, in most cases, lower costs means lower quality. During
World War IIWorld War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...
, for example, food sellers operating under ceilings reduced portion size and used less expensive ingredients (e.g., more fat, flour, etc.). It can also be seen in decreased maintenance of rent controlled apartments.
Some scholars, however, doubt that price ceilings necessarily drive quality down in the case of an
oligopolyAn oligopoly is a market form in which a market or industry is dominated by a small number of sellers . The word is derived, by analogy with "monopoly", from the Greek ὀλίγοι "few" + πόλειν "to sell". Because there are few sellers, each oligopolist is likely to be aware of the actions of the others...
. They argued that with few competing firms selling under a price ceiling, a company at the lower end of the market must find ways to achieve better quality without raising price.
Black markets
If somebody cannot obtain needed goods because a price ceiling reduces the quantity, they may turn to the black market. Those who—by luck or good management—obtain goods in short supply can
profitIn accounting, profit can be considered to be the difference between the purchase price and the costs of bringing to market whatever it is that is accounted as an enterprise in terms of the component costs of delivered goods and/or services and any operating or other expenses.-Definition:There are...
by illegally selling at a higher price than the free market allows. The black market price is higher than the free market price because the quantity is less than in a free market transaction, where more sellers could afford to sell the product. People are sometimes forced to buy at these higher prices when a shortage happens and there is no other place to obtain these.
Discrimination
If there is a shortage, sellers may discriminate among customers. In the case of rent control in
New York CityNew York is the most populous city in the United States and the center of the New York Metropolitan Area, one of the most populous metropolitan areas in the world. New York exerts a significant impact upon global commerce, finance, media, art, fashion, research, technology, education, and...
, landlords have given rent-controlled apartments to celebrities over less-wealthy, non-famous people.
Rent Control in New York City
Rent controlRent control refers to laws or ordinances that set price controls on the renting of residential housing. It functions as a price ceiling.Rent control exists in approximately 40 countries around the world...
is a price ceiling on rent. When soldiers returned from
World War IIWorld War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...
and started families (which increased demand for apartments), but stopped receiving military pay, many could not deal with the jumping rent. The government put in price controls, so soldiers and their families could pay the rent and keep their homes. However, this increased the quantity demanded for apartments and lowered the quantity supplied, meaning that available apartments were rapidly taken until none were left for late-comers. Price ceilings create shortages when producers are allowed to abdicate market share or go unsubsidized.
Apartment price control in Finland
According to professors Niko Määttänen and Ari Hyytinen, price ceilings on
HelsinkiHelsinki is the capital and largest city in Finland. It is in the region of Uusimaa, located in southern Finland, on the shore of the Gulf of Finland, an arm of the Baltic Sea. The population of the city of Helsinki is , making it by far the most populous municipality in Finland. Helsinki is...
City Hitas apartments are economically highly inefficient. They cause queuing, and discriminate against the handicapped, single parents, elderly, and others not able to queue for days. They cause inefficient allocation, as apartments are not bought by those willing to pay the most for them—and those who get an apartment are unwilling to leave it, even when their family or work situation changes, since they can't sell it at what they feel the market price should be. These inefficiencies increase apartment shortage and raise the market price of other apartments.
Coulter Law in VFL
As a result of declining competitive balance following the admission of Footscray,
HawthornThe Hawthorn Football Club, nicknamed the Hawks, is a professional Australian rules football club in the Australian Football League . The club, founded in 1902, is the youngest of the Victorian-based teams in the AFL. The team play in Brown & Gold vertically striped guernseys...
and
North MelbourneThe North Melbourne Football Club, nicknamed The Kangaroos, is the fourth oldest Australian rules football club in the Australian Football League and is one of the oldest sporting clubs in Australia and the world...
in 1925, the
VFLThe Australian Football League is both the governing body and the major professional competition in the sport of Australian rules football...
introduced a ceiling wage of £3 (around 160 Australian dollars at 2008 prices) in 1930. Known as the
Coulter Law after George Coulter, it was varied several times before finally being abolished in 1968, being cut in half during
World War IIWorld War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...
and increased in line with
inflationIn economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
after the war.
In its early years, poorer clubs did not have the money to pay their players even the legal wage, and
MelbourneThe Melbourne Football Club, nicknamed The Demons, is an Australian rules football club playing in the Australian Football League , based in Melbourne, Victoria....
preferred to give its players jobs rather than payments, but some clubs such as
RichmondThe Richmond Football Club, nicknamed The Tigers, is an Australian rules football club which competes in the Australian Football League. Richmond shares healthy rivalries with Carlton, Collingwood and Essendon. After winning five premierships between 1967 and 1980, the club hit the depths in 1990,...
did pay above the legal wage.
The Coulter Law was a strictly
binding price ceiling through its history, mainly for top players such as
Ron ToddRonald Walford Todd was an Australian rules footballer who played with Collingwood in the Victorian Football League in the 1930s, and with Williamstown in the Victorian Football Association in the 1940s. Todd was an acrobatic and pacy forward, possessing a strong overhead mark...
,
John ColemanJohn Douglas Coleman was an Australian rules footballer and coach for Essendon in the Victorian Football League ....
and
Brian GleesonBrian Gleeson is a former Australian rules footballer in the VFL.Gleeson attended St Patrick's College, Ballarat and later played with St Kilda at Centre half-forward initially. He developed into a skilful and agile ruckman, winning the Brownlow medal in 1957...
. In the case of Todd, it led to him moving to the VFA because he was dissatisfied with the pay he could legally get with
CollingwoodThe Collingwood Football Club, nicknamed The Magpies, is an Australian rules football club which plays in the Australian Football League...
, whilst Coleman and Gleeson could not afford
surgerySurgery is an ancient medical specialty that uses operative manual and instrumental techniques on a patient to investigate and/or treat a pathological condition such as disease or injury, or to help improve bodily function or appearance.An act of performing surgery may be called a surgical...
to continue their careers, that they would have been able to have on higher wages.
State Farm Insurance
A February 4, 2009 Wall St. Journal article stated, "Last month
State FarmState farm can refer to:*Sovkhoz, a type of state-owned farm in the Soviet Union*Volkseigenes Gut, a type of state-owned farm in East Germany*Państwowe Gospodarstwo Rolne, a type of state-owned farm in People's Republic of Poland...
pulled the plug on its 1.2 million homeowner policies in
FloridaFlorida is a state in the southeastern United States, located on the nation's Atlantic and Gulf coasts. It is bordered to the west by the Gulf of Mexico, to the north by Alabama and Georgia and to the east by the Atlantic Ocean. With a population of 18,801,310 as measured by the 2010 census, it...
, citing the state's punishing price controls... State Farm's local subsidiary recently requested an increase of 47%, but state regulators refused. State Farm says that since 2000 it has paid $1.21 in claims and expenses for every $1 of premium income received."
Venezuela
A January 10, 2006, BBC article reported that since 2003,
VenezuelaVenezuela , officially called the Bolivarian Republic of Venezuela , is a tropical country on the northern coast of South America. It borders Colombia to the west, Guyana to the east, and Brazil to the south...
President
Hugo ChavezHugo Rafael Chávez Frías is the 56th and current President of Venezuela, having held that position since 1999. He was formerly the leader of the Fifth Republic Movement political party from its foundation in 1997 until 2007, when he became the leader of the United Socialist Party of Venezuela...
has been setting price ceilings on food, and that these price ceilings have caused shortages and hoarding. A January 22, 2008 article from
Associated PressThe Associated Press is an American news agency. The AP is a cooperative owned by its contributing newspapers, radio and television stations in the United States, which both contribute stories to the AP and use material written by its staff journalists...
stated, "Venezuelan troops are cracking down on the smuggling of food... the National Guard has seized about 750 tons of food... Hugo Chavez ordered the military to keep people from smuggling scarce items like milk... He's also threatened to seize farms and milk plants..." On February 28, 2009 Chavez ordered the military to temporarily seize control of all the rice processing plants in the country and force them to produce at full capacity, which he alleged they had been avoiding in response to the price caps.
A January 3, 2007 article in the
International Herald TribuneThe International Herald Tribune is a widely read English language international newspaper. It combines the resources of its own correspondents with those of The New York Times and is printed at 38 sites throughout the world, for sale in more than 160 countries and territories...
reported that Chavez's price ceilings were causing shortages of materials used in the construction industry. According to an April 4, 2008 article from
CBS NewsCBS News is the news division of American television and radio network CBS. The current chairman is Jeff Fager who is also the executive producer of 60 Minutes, while the current president of CBS News is David Rhodes. CBS News' flagship program is the CBS Evening News, hosted by the network's main...
, Chavez ordered the nationalization of the cement industry in response to the industry exporting its products to receive higher prices outside the country.
See also
- Price floor
A price floor is a government- or group-imposed limit on how low a price can be charged for a product. For a price floor to be effective, it must be greater than the equilibrium price.-Effectiveness of price floors:...
- General equilibrium
General equilibrium theory is a branch of theoretical economics. It seeks to explain the behavior of supply, demand and prices in a whole economy with several or many interacting markets, by seeking to prove that a set of prices exists that will result in an overall equilibrium, hence general...
- Black market