What Are the Effects of Price Ceiling and Price Floors

(a)

Price Ceiling

Price ceiling occurs when the government puts a legal limit on how high the price of a product or service can be. Price Ceilings are maximum prices set by the government for particular goods and services that they believe are being sold at too high of a price and thus consumers need some help purchasing them. In order for a price ceiling to be effective it must be set below the natural market equilibrium.

When the ceiling is set below the market price, there will be excess demand or a supply shortage. Producers won't produce as much at the lower price, while consumers will demand more because the goods are cheaper. Demand will outstrip supply, so there will be a lot of people who want to buy at this lower price but can't. Still, if the demand curve is relatively elastic, then the net effect to consumer surplus will be positive. Producers are truly harmed, as their surplus is doubly hit with a reduction in the number of firms willing to take that lower price, and those who remain in the market have to take a lower price.

Figure 1

The diagram above shows an effective price ceiling. The diagram (Figure 1), the price ceiling is set at Pc, which is below the natural equilibrium. The equilibrium price is Pe which will guarantee supply of Qe. If a price ceiling is set at Pc, the quantity which can be supplies into the market is Qs but the demand is Qd which will create a shortage in the market Od-Qs. What it means is the market is now prepared to buy quantity Qd but producers can only supply Qs.

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. Price Floors are minimum prices set by the government for certain commodities and services that it believes are being sold in an unfair market with too low of a price and thus their producers deserve some assistance. Price floors are only an issue when they are...