While price ceilings might seem to be an obviously good thing for consumers, they also carry long-term ramifications. Certainly, costs go down in the short run, which can stimulate demand. However, producers need to 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.
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. In the aftermath of World War II, homecoming veterans were flocking and establishing families—and rent rates for apartments were skyrocketing, as a major housing shortage ensued.
The original post-war rent control applied only to specific types of buildings. However, it continued in a somewhat less restricted form, called rent stabilization, into the s. In New York City, rent control tenants are generally in buildings built before Feb. Rent stabilization applies to buildings of six or more units built between February 1, , and Dec. The aim was to help maintain an adequate supply of affordable housing in the cities.
However, the actual effect, critics say, has been to reduce the overall supply of available residential rental units in New York City, which in turn has led to even higher prices in the market. Further, some housing analysts say, controlled rental rates also discourage landlords from having the needed funds, or at least committing the necessary expenditures, to maintain or improve rental properties, leading to deterioration in the quality of rental housing.
The opposite of a price ceiling is a price floor, which sets a minimum purchase cost for a product or service. A minimum wage is a familiar type of price floor. Operating on the premise that someone working full time ought to earn enough to afford a basic standard of living, it sets the lowest legal amount that a job can pay. Both floors and ceilings are forms of price controls. Like a price ceiling, a price floor may be set by the government or, in some cases, by producers themselves.
Federal or municipal authorities may actually name specific figures for the floors, but often they 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, for example, to mitigate the swings in supply and farmers' income that can commonly occur, due to factors beyond their control. The big pro of a price ceiling is, of course, the limit on costs for the consumer.
If it's just a temporary shortage that's causing rampant inflation, ceilings can mitigate the pain of higher prices until supply returns to normal levels again.
Price ceilings can also stimulate demand and encourage spending. So, in the short term, price ceilings have their advantages. They can get to be a problem, though, if they continue too long, or when they are set too far below the market equilibrium price when the quantity demanded equals the quantity supplied.
When they do, demand can skyrocket, leading to shortages in supply. Also, if the prices producers are allowed to charge are too out of line with their production costs and business expenses, something will have to give. They may have to cut corners, reducing quality, or charge higher prices on other products. They may have to discontinue offerings or not produce as much causing more shortages.
Some may be driven out of business if they can't realize a reasonable profit on their goods and services. In the s, the U. As a result, shortages quickly developed. The regulated prices seemed to function as a disincentive to domestic oil companies to step up or even maintain production, as was needed to counter interruptions in oil supply from the Middle East. As supplies fell short of demand, shortages developed and rationing was often imposed through schemes like alternating days in which only cars with odd- and even-numbered license plates would be served.
Those 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 some new expenses. Some gas stations sought to compensate for lost revenue by making formerly optional services such as washing the windshield a required part of filling up and imposed charges for them. The consensus of economists is that consumers would have been better off in every respect had controls never been applied.
If the government had simply let prices increase, they argue, the long lines at gas stations may never have developed, and the surcharges never imposed. Those who manage to purchase the product at the lower price given by the price ceiling will benefit, but sellers of the product will suffer, along with those who are not able to purchase the product at all. To the extent that producers cannot easily reduce the quantity supplied, they will tend to allow the quality to decline.
The following video explores the effects of price ceilings. The speakers identify five major consequences:. The first two consequences are explained in the video. Improve this page Learn More. Skip to main content. Module 4: Applications of Supply and Demand. Search for:. Price Ceilings Learning Objectives Analyze the consequences of the government setting a binding price ceiling, including the economic impact on price, quantity demanded and quantity supplied Compute and demonstrate the market shortage resulting from a price ceiling.
Watch It Watch this video to see a historical example of what happened to the U. Try It. Watch It The following video explores the effects of price ceilings. The speakers identify five major consequences: Shortages Reduced quality Wasted time and resources Deadweight loss, or a loss of gains from trade Misallocation of resources The first two consequences are explained in the video. Glossary binding price ceiling when a price ceiling is set below the equilibrium price, resulting in a shortage price ceiling: a legal maximum price for a product price floor: a legal minimum price for a product.
Did you have an idea for improving this content? Licenses and Attributions. CC licensed content, Original. Price floors are only an issue when they are set above the equilibrium price, since they have no effect if they are set below market clearing price. When they are set above the market price, then there is a possibility that there will be an excess supply or a surplus.
If this happens, producers who can't foresee trouble ahead will produce the larger quantity where the new price intersects their supply curve. Unbeknownst to them, consumers will not buy that many goods at the higher price and so those goods will go unsold. There will be economic harm done even if suppliers can look ahead and see that there isn't sufficient demand and cut back on production in response.
There is still deadweight loss associated with this reduction in quantity, reflected in the loss of consumer and producer surplus at lower levels of production.
Producers can gain as a result of this policy, but only if their supply curve is relatively elastic and therefore they have no net loss. Consumers will definitely lose with this kind of regulation, as some people are priced out of the market and others have to pay a higher price than before. There are numerous strategies of the government for setting a price floor and dealing with its repercussions. They can set a simple price floor, use a price support, or set production quotas. Price supports sets a minimum price just like as before, but here the government buys up any excess supply.
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