price-ceiling

What Is A Price Ceiling? Price Ceiling In A Nutshell

A price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity. Price ceilings are limits imposed on the price of a product, service, or commodity to protect consumers from prohibitively expensive items. These limits are usually imposed by the government but can also be set in the resale price maintenance (RPM) agreement between a product manufacturer and its distributors. 

Understanding a price ceiling

Laws enacted by the government to regulate prices are known as price controls. These controls come in two types:

  1. A price ceiling – which keeps a price from rising above a certain level, and
  2. A price floor – which keeps a price from falling below a certain level.

The supply and demand framework can be used to better understand price ceilings. When demand for a product or service outpaces supply, consumers sometimes lobby politicians to ensure prices do not increase to the point where they become unaffordable.

When rent prices rise in a city because of gentrification or some other reason, for example, residents may press political leaders to enact laws that stipulate that rent prices can only be raised by a maximum percentage each year.

Price ceilings and opportunity cost

Price ceilings, like most concepts in economics, have various opportunity costs. 

When a control is placed on rent prices, some individuals may be evicted as landlords convert their premises into office space or holiday apartments. What’s more, landlords may spend less on maintenance such as heating, cooling, and hot water because the rental income on their property has been capped.

Irrespective of the situation, price ceilings are enacted in an attempt to keep prices affordable for those who are demanding the product. However, these price controls can prevent the market from reaching an equilibrium point where supply equals demand. When this does not occur, demand will continue to outpace supply and a shortage of the good or service will ensue.

Buyers who do manage to purchase below the price ceiling will benefit. But as we saw with the landlord example, sellers will tend to be disadvantaged and the quality of a product or service is also more likely to deteriorate. 

To compensate for lower prices, producers may also reduce their output or charge for previously free options or product features. Both strategies exacerbate problems the price ceiling was implemented to address.

Price ceiling examples

Here are some real-world examples of price ceiling implementation:

  1. Health care – many governments around the world set a price ceiling on prescription drugs to ensure everyone has access to affordable medication. There are similar controls on the price of doctor and hospital visits. 
  2. Gasoline prices – when oil prices increased during the 1970s because of an embargo, the U.S. government imposed a ceiling on the price of gasoline. The initiative caused oil shortages to develop as domestic oil companies were hesitant to increase supply in a market where prices were capped. To compensate for lost revenue, some gas stations also made optional services such as windshield washing compulsory.
  3. Hurricane Sandy – after Hurricane Sandy hit the United States in 2012, the states of New Jersey and New York set price ceilings on basic goods such as bottled water and gasoline. This prevented price gouging and gave consumers access to basic necessities.
  4. Salary caps – though not instituted by the government, most professional sports teams must work under a salary cap that stipulates how much they can pay their players. The intention here is to prevent wealthy teams from acquiring the best players and dominating the league.

Key takeaways:

  • A price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity.
  • Price ceilings are associated with various opportunity costs because they hinder the market’s ability to reach the equilibrium level. Producers may limit output and product quality may decrease to compensate for price controls.
  • Price ceilings are commonly implemented in the healthcare system and in professional sports to limit player salaries. They are also an integral part of disaster response management and have been used in the wake of Hurricane Sandy and the oil crisis of the early 1970s.

Main Free Guides:

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