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:

Connected Business Concepts

Economies of Scale

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 organization scale further.

Diseconomies of Scale

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.

Network Effects

In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

Negative Network Effects

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.

Creative Destruction

Creative destruction was first described by Austrian economist Joseph Schumpeter in 1942, who suggested that capital was never stationary and constantly evolving. To describe this process, Schumpeter defined creative destruction as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Therefore, creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets.

Happiness Economics

Happiness economics seeks to relate economic decisions to wider measures of individual welfare than traditional measures which focus on income and wealth. Happiness economics, therefore, is the formal study of the relationship between individual satisfaction, employment, and wealth.

Command Economy

In a command economy, the government controls the economy through various commands, laws, and national goals which are used to coordinate complex social and economic systems. In other words, a social or political hierarchy determines what is produced, how it is produced, and how it is distributed. Therefore, the command economy is one in which the government controls all major aspects of the economy and economic production.

Animal Spirits

The term “animal spirits” is derived from the Latin spiritus animalis, loosely translated as “the breath that awakens the human mind”. As far back as 300 B.C., animal spirits were used to explain psychological phenomena such as hysterias and manias. Animal spirits also appeared in literature where they exemplified qualities such as exuberance, gaiety, and courage.  Thus, the term “animal spirits” is used to describe how people arrive at financial decisions during periods of economic stress or uncertainty.

State Capitalism

State capitalism is an economic system where business and commercial activity is controlled by the state through state-owned enterprises. In a state capitalist environment, the government is the principal actor. It takes an active role in the formation, regulation, and subsidization of businesses to divert capital to state-appointed bureaucrats. In effect, the government uses capital to further its political ambitions or strengthen its leverage on the international stage.

Boom And Bust Cycle

The boom and bust cycle describes the alternating periods of economic growth and decline common in many capitalist economies. The boom and bust cycle is a phrase used to describe the fluctuations in an economy in which there is persistent expansion and contraction. Expansion is associated with prosperity, while the contraction is associated with either a recession or a depression.
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