Price Ceiling: Effects, Types, and Implementation in Economics

What Is a Price Ceiling?

A price ceiling is the mandated maximum amount that a seller is permitted to charge for a product or service. Price ceilings are usually set by law and are typically applied to staples such as food and energy products when these goods become unaffordable to regular consumers.

Price ceilings are essentially a type of price control. They can be advantageous in allowing essentials to be affordable, at least temporarily, but economists question how beneficial such ceilings are in the long run.

How a Price Ceiling Works

Price ceilings are implemented when a regulator sets a maximum price they believe is acceptable or appropriate. All sellers must offer their products at a price equal to or below this amount and the sale of goods is regulated and monitored. How companies offer their products can be regulated and monitored as well.

Regulators review the price ceiling regularly to ensure that it still represents an appropriate level. They perpetually evaluate market supply and demand to best understand whether the price ceiling should be increased or decreased. A good may experience an unexpected shortage. The regulators may decide that a price ceiling may negatively influence producers or impact product quality in this case, thus necessitating the removal of the ceiling.

Price ceilings might seem to be a good thing for consumers but they also carry long-term ramifications. Costs go down in the short run and this can stimulate demand, but producers must find some way to compensate for the price and profit controls. They may ration supply, cut back on production or production quality, or charge extra for formerly free options and features.

As a result, economists wonder how efficient price ceilings can be at protecting the most vulnerable consumers from high costs or even protecting them at all. A broader and more theoretical objection to price ceilings is that they create a deadweight loss to society. This describes an economic deficiency caused by an inefficient allocation of resources that disturbs the equilibrium of a marketplace and contributes to making it more inefficient.

Real-World Cases of Price Ceilings

There are several types of government-enforced price ceilings, usually for goods that are considered essential.

Rent Ceilings

Some areas have rent ceilings to protect renters from rapidly climbing rates on residences. Such rent controls are a frequently cited example of the ineffectiveness of price controls in general and price ceilings in particular.

Rent controls were widely implemented in New York City and throughout New York State in the late 1940s. Homecoming veterans were flocking and establishing families in the aftermath of World War II and rent rates for apartments skyrocketed as a major housing shortage ensued. The original post-war rent control applied only to specific types of buildings but it continued into the 1970s in a somewhat less restricted form that was referred to as rent stabilization.

The aim was to help maintain an adequate supply of affordable housing in the cities but critics say the effect has been to reduce the overall supply of available residential rental units in New York City, which has in turn led to even higher prices in the market.

Some housing analysts further say that controlled rental rates discourage landlords from having the necessary funds or at least committing to the necessary expenditures to maintain or improve their rental properties. This can lead to deterioration in the quality of rental housing.

Food and Fuel Price Caps

Some governments may cap the prices of essential goods such as food and fuel to ensure access to these essential goods and to prevent profiteering. The German government pledged to cap energy prices due to the shortage of Russian natural gas following the Russian invasion of Ukraine in 2022.

Prescription Drugs and Laboratory Tests

There's a strong incentive for medical equipment and drug manufacturers in the United States to raise prices knowing that the increased cost will most likely fall on taxpayers or insurance companies. President Biden signed the Inflation Reduction Act in 2022. It includes price caps on the negotiated prices of certain drugs to prevent further price rises.

Rideshares

Rideshare services could charge much higher fares during peak hours as the popularity of Uber and other rideshare services boomed. This price variability concerned India and the Karnataka government decided to implement the price per kilometer that Uber and other rideshares could charge.

The government noted in the long run that passengers often had to wait longer to get an Uber because fewer drivers were incentivized even though more riders demonstrated interest in using their rideshare services.

Salary Caps

Price ceilings in professional sports can relate to the maximum amount a single employee may receive in compensation. Consider this agreement between the National Basketball Association and the National Basketball Players Association. The collective bargaining agreement between the two associations outlines several situations where a player is eligible to receive a maximum salary. These are the terms for newer players in the league with less than seven years of service:

Price Ceiling vs. Price Floor

A price floor is the opposite of a price ceiling. It sets a minimum purchase cost for a product or service. Also known as price support, it represents the lowest legal amount at which a good or service can be sold and still function within the traditional supply and demand model.

Both floors and ceilings are forms of price controls. Like a price ceiling, a price floor may be set by the government or by producers themselves in some cases. Federal or municipal authorities may name specific figures for the floors but they often operate simply by entering the market and buying the product, thus propping its prices up above a certain level.

Many countries periodically impose floors on agricultural crops and products to mitigate the swings in supply and farmers' incomes that can commonly occur due to factors beyond their control.

Effects of Price Ceilings

Price ceilings are intended to ensure access to the most essential goods but they may sometimes have the counterintuitive effect of making those goods less accessible. This can happen because the government-enforced price doesn't reflect the market forces of supply and demand.

Many municipal governments enforce policies that limit rises in rental prices to keep housing more affordable. Landlords are unable to raise rents when housing is in short supply. Developers are less likely to fund new developments because of these restrictions. Their profits will be limited by existing rent controls. The supply of housing is less likely to increase in these cities as a result, even when there's a shortage.

Types of Price Ceilings

Governments can implement several types of price ceilings depending on the good that's being regulated and the entity that's doing the regulating.

• Absolute Price Ceiling: This is a fixed limit on the price that can be charged for a good or service. The price can't go higher than this limit. A government can vote or decide to periodically change the absolute price ceiling but these ceiling limit changes are often infrequent enough to uphold the usefulness of the regulation.
• Relative Price Ceiling: This is a limit on the price of a good or service in relation to another good or service. A government might set a relative price ceiling on rent in relation to the average income of renters in a particular area. The government would closely monitor the independent variable in this case to better understand how the dependent variable's price ceiling fluctuates.
• Per Unit Price Ceiling: This is a limit on the price of a good or service per unit. A government might set a per-unit price ceiling on the price of gasoline. This is similar to the absolute price ceiling although a consumer could theoretically spend as much as they wanted if they were to buy higher amounts of quantities.
• Periodic Price Ceiling: This is a limit on the price of a good or service for a specific period. A government might set a periodic price ceiling on electricity during the summer months when demand is high. Governments may enact periodic price ceilings during times of emergency.
• Selective Price Ceiling: This is a limit on the price of a specific type of good or service. A government might set a selective price ceiling on prescription drugs to make them more affordable for consumers.

Advantages and Disadvantages of Price Ceilings

The big pro of a price ceiling is the limit on costs for the consumer. It keeps things affordable and prevents price-gouging and producers/suppliers from taking unfair advantage of them. Ceilings can mitigate the pain of higher prices until supply returns to normal levels if it's just a temporary shortage that's causing rampant inflation. Price ceilings can also stimulate demand and encourage spending.

Price ceilings have their advantages in the short term but they can become a problem if they continue for too long or when they're set too far below the market equilibrium price when the quantity demanded equals the quantity supplied. Demand can skyrocket when this happens, leading to shortages in supply.

Something will have to give if the prices that producers are allowed to charge are too out of line with their production costs and business expenses. They may have to cut corners, reduce quality, or charge higher prices on other products. They may have to discontinue offerings or not produce as much, causing more shortages. Some may even be driven out of business if they can't realize a reasonable profit on their goods and services.

Example of a Price Ceiling

The U.S. government imposed price ceilings on gasoline after some sharp rises in oil prices in the 1970s. Shortages quickly developed as a result. The regulated prices seemed to function as a disincentive to domestic oil companies to step up or even maintain production as was necessary to counter interruptions in oil supply from the Middle East.

Shortages developed and rationing was often imposed as supplies fell short of demand. This was achieved through schemes like alternating days in which only cars with odd- and even-numbered license plates could be served. These long waits imposed costs on the economy and motorists through lost wages and other negative economic impacts.

The supposed economic relief of controlled gas prices was also offset by new expenses. Some gas stations sought to compensate for lost revenue by making formerly optional services a required part of filling up, such as washing the windshield. They imposed charges for them.

The consensus of economists is that consumers would have been better off in every respect had controls never been applied. They argue that the long lines at gas stations would never have developed if the government had simply let prices increase. Oil companies would have bumped up production due to the higher prices and consumers who now had a stronger incentive to conserve gas would have limited their driving or bought more energy-efficient cars.

The Bottom Line

Price ceilings prevent a price from rising above a certain level. They're a form of price control. They often benefit consumers in the short run but the long-term effects of price ceilings are complex. They can negatively impact producers and sometimes even the consumers they aim to help by causing supply shortages and a decline in the quality of goods and services.