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.
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Understanding a price ceiling
Laws enacted by the government to regulate prices are known as price controls. These controls come in two types:
A price ceiling – which keeps a price from rising above a certain level, and
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:
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.
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.
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.
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.
Key Highlights:
Price Ceiling:
A price ceiling is a government-imposed limit on the maximum price that can be charged for a product, service, or commodity.
It is a form of price control aimed at ensuring affordability for consumers.
Price Controls:
Price controls are regulations established by the government to influence market prices.
They can be in the form of price ceilings (limiting maximum prices) or price floors (limiting minimum prices).
Supply and Demand Framework:
Price ceilings often result from demand outpacing supply, leading to concerns about affordability.
Opportunity Costs of Price Ceilings:
Price ceilings have opportunity costs, such as reduced supply, lower quality, and unintended consequences.
For example, landlords might reduce maintenance efforts due to capped rental income.
Impact on Market Equilibrium:
Price ceilings can prevent the market from reaching an equilibrium where supply matches demand, leading to shortages.
Examples of Price Ceilings:
Health care: Governments set price ceilings on prescription drugs and medical services to ensure access to affordable healthcare.
Gasoline prices: The US government imposed a price ceiling on gasoline during the 1970s oil crisis, causing shortages.
Disaster response: After Hurricane Sandy, price ceilings were placed on goods like bottled water to prevent price gouging.
Salary caps: Professional sports teams often adhere to salary caps to ensure competitive balance.
Revenue model patterns are a way for companies to monetize their business models. A revenue model pattern is a crucial building block of a business model because it informs how the company will generate short-term financial resources to invest back into the business. Thus, the way a company makes money will also influence its overall businessmodel.
A pricingstrategy or model helps companies find the pricing formula in fit with their business models. Thus aligning the customer needs with the product type while trying to enable profitability for the company. A good pricingstrategy aligns the customer with the company’s long term financial sustainability to build a solid businessmodel.
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.
Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It can be described as elastic, where consumers are responsive to price changes, or inelastic, where consumers are less responsive to price changes. Price elasticity, therefore, is a measure of how consumers react to the price of products and services.
Price skimming is primarily used to maximize profits when a new product or service is released. Price skimming is a productpricingstrategy where a company charges the highest initial price a customer is willing to pay and then lowers the price over time.
Productized services are services that are sold with clearly defined parameters and pricing. In short, that is about taking any product and transforming it into a service. This trend has been strong as the subscription-based economy developed.
Menu costs describe any cost that a business must absorb when it decides to change its prices. The term itself references restaurants that must incur the cost of reprinting their menus every time they want to increase the price of an item. In an economic context, menu costs are expenses that are incurred whenever a business decides to change its prices.
A price floor is a control placed on a good, service, or commodity to stop its price from falling below a certain limit. Therefore, a price floor is the lowest legal price a good, service, or commodity can sell for in the market. One of the best-known examples of a price floor is the minimum wage, a control set by the government to ensure employees receive an income that affords them a basic standard of living.
Predatory pricing is the act of setting prices low to eliminate competition. Industry dominant firms use predatory pricing to undercut the prices of their competitors to the point where they are making a loss in the short term. Predatory prices help incumbents keep a monopolistic position, by forcing new entrants out of the market.
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.
The bye-now effect describes the tendency for consumers to think of the word “buy” when they read the word “bye”. In a study that tracked diners at a name-your-own-price restaurant, each diner was asked to read one of two phrases before ordering their meal. The first phrase, “so long”, resulted in diners paying an average of $32 per meal. But when diners recited the phrase “bye bye” before ordering, the average price per meal rose to $45.
The anchoring effect describes the human tendency to rely on an initial piece of information (the “anchor”) to make subsequent judgments or decisions. Price anchoring, then, is the process of establishing a price point that customers can reference when making a buying decision.
A price maker is a player who sets the price, independently from what the market does. The price setter is the firm with the influence, market power, and differentiation to be able to set the price for the whole market, thus charging more and yet still driving substantial sales without losing market shares.
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organizationscale further.
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.
A network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
