What is a 'Price Ceiling'
A price ceiling is the maximum price a seller is allowed to charge for a product or service. Price ceilings are usually set by law and limit the seller pricing system to ensure fair and reasonable business practices. Price ceilings are often set for essential expenses; for example, some areas have rent ceilings to protect renters from climbing rent prices.
BREAKING DOWN 'Price Ceiling'Price ceilings are regulations designed to protect low-income individuals from not being able to afford important resources. However, many economists question their effectiveness for several reasons. For example, price ceilings have no effect if the equilibrium price of the good is below the ceiling. In contrast, if the ceiling is set below the equilibrium level, a dead-weight loss is created.
Disadvantages of Price Ceilings
Price ceilings, while advantageous for many reasons, can also carry disadvantages. For example, in the 1970s, when the government imposed a price ceiling on gasoline prices, the price of gas was relatively low. To take advantage of those low prices, consumers waited in long lines to buy gas. In addition to the inconvenience of having to spend a lot of time getting gas, this caused a shortage. Arguably, if the government had simply let prices increase, consumers would have been forced to conserve, lines would have stayed short and a shortage may not have ensued.
Another risk of price ceilings is retailers may attempt to get around these regulations with fees. For example, a business may sell an item below the price ceiling but may assess fees for related products or services to indirectly drive up the price past the ceiling.
Difference Between Price Ceilings and Price Floor
Both price ceilings and floors are forms of price controls. While a price ceiling dictates the maximum price of a good or service, a price floor refers to the lowest price for which a good or service may be sold. Both of these concepts are based on the idea of protecting the consumer or the market. However, price ceilings can be linked with shortages. Namely, if too many consumers can afford a good, they may all buy it, and supplies may fall short. Conversely, price floors can correlate with surpluses. If the floor makes the product or service unaffordable, few people are likely to buy it, creating a surplus.
How Price Ceilings Cause Shortages
To understand how price ceilings cause shortages, imagine an area has been devastated by a tornado. As the community rebuilds, there is high demand for plywood, and to boost profits, businesses increase the price of plywood. However, the community protests this increase and demands a price ceiling. The city complies and forbids retailers from charging over a certain amount for plywood. In turn, as prices fall, suppliers become less willing to sell plywood to the stores in the area due to their diminishing profit margin, and a shortage ensues.