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definition - Price ceiling

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Price ceiling

                   
  Non-binding price ceiling
  Pricing, quantity, and welfare effects of a binding price ceiling

A price ceiling is a government-imposed limit on the price charged for a product. Governments intend price ceilings to protect consumers from conditions that could make necessary commodities unattainable. However, a price ceiling can cause problems if imposed for a long period without controlled rationing. Price ceilings can produce negative results when the correct solution would have been to increase supply. Misuse occurs when a government misdiagnoses a price as too high when the real problem is that the supply is too low. In an unregulated market economy price ceilings do not exist. Students may incorrectly perceive a price ceiling as being on top of a supply and demand curve when in fact, an effective price ceiling is positioned below the equilibrium position on the graph.

Contents

  Effects

  Binding versus non-binding

A price ceiling can be set above or below the free-market equilibrium price. For a price ceiling to be effective, it must differ from the free market price. In the graph at right, the supply and demand curves intersect to determine the free-market quantity and price. The dashed line represents a price ceiling set above the free-market price, called a non-binding price ceiling. In this case, the ceiling has no practical effect. The government has mandated a maximum price, but the market price is established well below that. In contrast, the solid green line is a price ceiling set below the free market price, called a binding price ceiling. In this case, the price ceiling has a measurable impact on the market.

  Consequences of binding price ceilings

A price ceiling set below the free-market price has several effects. Suppliers find they can't charge what they had been. As a result, some suppliers drop out of the market. This reduces supply. Meanwhile, consumers find they can now buy the product for less, so quantity demanded increases. These two actions cause quantity demanded to exceed quantity supplied, which causes a shortage—unless rationing or other consumption controls are enforced. It can also lead to various forms of non-price competition so supply can meet demand.

  Reduction in quality

To supply demand at the legal price, the most obvious approach is to lower costs. However, in most cases, lower costs means lower quality. During World War II, for example, food sellers operating under ceilings reduced portion size and used less expensive ingredients (e.g., more fat, flour, etc.). It can also be seen in decreased maintenance of rent-controlled apartments.[1]

Some scholars, however, doubt that price ceilings necessarily drive quality down in the case of an oligopoly.[2] They argued that with few competing firms selling under a price ceiling, a company at the lower end of the market must find ways to achieve better quality without raising price.

  Black markets

If somebody cannot obtain needed goods because a price ceiling reduces the quantity, they may turn to the black market. Those who—by luck or good management—obtain goods in short supply can profit by illegally selling at a higher price than the free market allows. The black market price is higher than the free market price because the quantity is less than in a free market transaction, where more sellers could afford to sell the product. People are sometimes forced to buy at these higher prices when a shortage happens and there is no other place to obtain these.

  Discrimination

If there is a shortage, sellers may discriminate among customers. In the case of rent control in New York City, landlords have given rent-controlled apartments to celebrities over less-wealthy, non-famous people.[citation needed]

  Real world examples

  Rent control in New York City

Rent control is a price ceiling on rent. When soldiers returned from World War II and started families (which increased demand for apartments), but stopped receiving military pay, many could not deal with the jumping rent. The government put in price controls, so soldiers and their families could pay the rent and keep their homes. However, this increased the quantity demanded for apartments and lowered the quantity supplied, meaning that available apartments were rapidly taken until none were left for late-comers. Price ceilings create shortages when producers are allowed to abdicate market share or go unsubsidized.

  Apartment price control in Finland

According to professors Niko Määttänen and Ari Hyytinen, price ceilings on Helsinki City Hitas apartments are economically highly inefficient. They cause queuing, and discriminate against the handicapped, single parents, elderly, and others not able to queue for days. They cause inefficient allocation, as apartments are not bought by those willing to pay the most for them—and those who get an apartment are unwilling to leave it, even when their family or work situation changes, since they can't sell it at what they feel the market price should be. These inefficiencies increase apartment shortage and raise the market price of other apartments.[3]

  Coulter law in VFL

As a result of declining competitive balance following the admission of Footscray, Hawthorn and North Melbourne in 1925,[4][5] the VFL introduced a ceiling wage of £3 (around 160 Australian dollars at 2008 prices) in 1930. Known as the Coulter Law after George Coulter, it was varied several times before finally being abolished in 1968, being cut in half during World War II and increased in line with inflation after the war.

In its early years, poorer clubs did not have the money to pay their players even the legal wage, and Melbourne preferred to give its players jobs rather than payments, but some clubs such as Richmond did pay above the legal wage.

The Coulter Law was a strictly binding price ceiling through its history, mainly for top players such as Ron Todd, John Coleman and Brian Gleeson. In the case of Todd, it led to him moving to the VFA because he was dissatisfied with the pay he could legally get with Collingwood,[6] whilst Coleman and Gleeson could not afford surgery to continue their careers, that they would have been able to have on higher wages.

  State Farm Insurance

A February 4, 2009 Wall Street Journal article stated, "Last month State Farm pulled the plug on its 1.2 million homeowner policies in Florida, citing the state's punishing price controls...State Farm's local subsidiary recently requested an increase of 47%, but state regulators refused. State Farm says that since 2000 it has paid $1.21 in claims and expenses for every $1 of premium income received."[7]

  Venezuela

A January 10, 2006, BBC article reported that since 2003, Venezuela President Hugo Chavez has been setting price ceilings on food, and that these price ceilings have caused shortages and hoarding.[8] A January 22, 2008 article from Associated Press stated, "Venezuelan troops are cracking down on the smuggling of food... the National Guard has seized about 750 tons of food... Hugo Chavez ordered the military to keep people from smuggling scarce items like milk... He's also threatened to seize farms and milk plants..."[9] On February 28, 2009 Chavez ordered the military to temporarily seize control of all the rice processing plants in the country and force them to produce at full capacity, which he alleged they had been avoiding in response to the price caps.[10]

A January 3, 2007 article in the International Herald Tribune reported that Chavez's price ceilings were causing shortages of materials used in the construction industry.[11] According to an April 4, 2008 article from CBS News, Chavez ordered the nationalization of the cement industry in response to the industry exporting its products to receive higher prices outside the country.[12]

  References

  See also

   
               

 

All translations of Price ceiling


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