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 writing customer service . 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. Effects of Price Ceilings Binding Versus Non-Binding price ceilings 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 mean 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. Some scholars, however, doubt that price ceilings necessarily drive quality down in the case of an oligopoly. 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.