Price ceiling definition economics
What is a price ceiling? A ceiling price implies that the government has fixed the maximum permitted price for a specific good and in price ceiling graph, it is set below the market equilibrium.
When the government implements a ceiling price on a particular good, no seller can sell higher than that price. Sellers can mark the ceiling price as the maximum retail price of that good. If sellers sell higher than the ceiling price, this is an illegal market activity.
What is the purpose of a price ceiling?
Price ceilings are intended to address the problem of high unreasonable market prices. Price ceilings are designed to benefit consumers. Because when the market price is too expensive for the consumers, the government sets a ceiling price on the good. Sellers may then sell their goods for on or less than the ceiling price. The price of necessities like food, power, gas, medication, and other commodities is typically controlled under the ceiling price.
The government believes that price ceilings can, at least temporarily, make costs accessible for consumers. To make various products more affordable for customers, government has set maximum prices for the products. A price ceiling is created by governments to ensure social welfare and development.
Binding vs non binding price ceiling
What is a binding price ceiling (effective ceiling price)?
When is price ceiling binding? A price ceiling is binding when it is set below the market equilibrium price. In other words, an effective price ceiling will be laid below the equilibrium price is determined by the market forces. However a binding price ceiling causes a shortage in the market.
What is a non binding price ceiling (ineffective ceiling price)?
When is price ceiling nonbinding? A price ceiling is non binding when it is set on or above the market equilibrium price. In other words, an ineffective price ceiling will be laid on or above the equilibrium price is determined by the market forces.
When government imposes a non binding price ceiling, sellers sell the product at market equilibrium price. Because if they sell the product at a price above the market equilibrium price, there will be a surplus in the market. So, in this situation price ceiling will be ineffective.
Price ceiling graph
I will explain the concept of ceiling price using a graph of price ceiling.
Assume that government imposes a ceiling price on sugar. So, the following price ceiling graph shows the impact of the ceiling price on sugar.
The equilibrium quantity of sugar is Q*, and the equilibrium price is P*, as seen in the above graph before the ceiling price. Following that, the government sets a maximum price (or “Pmax”) for sugar.
Price ceiling creates shortage. There is a market shortage of sugar (The demand exceeds the supply). Qd is higher than the Qs. Because of this, some consumers could not able to purchase sugar.
Black market price
Price ceiling creates black market price. According to above graph of price ceiling, there will be a black-market price which is the “price – Pb”. The “price – Pb” is the market price that relates to the “Qs” quantity of supply. Suppliers can sell the Qs quantity to the consumers under the “Pb” price in the black-market. Because there is sufficient demand for sugar under this price. So, ultimately because of the price ceiling, some customers are not able to buy sugar while only some customers can buy sugar at the black-market price. So, the ceiling price creates market inefficiency.
What are examples of price ceilings?
Price ceiling example in real life
Maximum price on medicine
For the benefit of patients, governments in various nations impose price caps on prescription medications and other medical procedures. For instance, in the UK, the National Health Service bargains with pharmaceutical companies about prices and establishes a price cap on the medications it covers.
Price cap on gasoline
Governments may establish price ceilings on gasoline during emergencies or natural disasters in order to stop sellers from charging too much consumers. For instance, after Hurricane Sandy damaged New York and New Jersey in 2012, the state governments set price caps on gasoline to stop sellers from charging excessive prices.
In order to address a housing scarcity and stop landlords from taking advantage of the high demand for rental units, rent control was introduced in New York City in the 1940s. Many low-income households are still living in their homes thanks to rent regulation.
A price ceiling example with graph
During the COVID 19 pandemic, the price of face masks have been increased up to a too high level. Assume that, in USA face mask price has increased up to $0.4. At this price the market demand and supply were 2 million of face marks.
I will draw the market equilibrium as follows
Calculate consumer surplus
Consumer surplus = (maximum demand price– equilibrium price) * equilibrium quantity /2
So, consumer surplus equals to blue coloured area
Consumer surplus = (1 – 0.4) *2/2 = $0.6 million
Calculate producer surplus
producer surplus = (equilibrium price – minimum supply price) * equilibrium quantity /2
So, producer surplus equals to green coloured area
producer surplus = (0.4– 0) *2/2 = $0.4 million
Calculate economic surplus
Also, the economic surplus is $1 million.
Economic surplus = producer surplus + consumer surplus
Economic surplus = 0.4 + 0.6 = $1 million
Binding price ceiling graph
The USA government has implemented a ceiling price of $0.2 on the face mask. So, ceiling price of $0.2 on the face mask is less than the market equilibrium price. We will draw the impact of price ceiling on a graph as follows.
Price ceiling creates shortage. Shortage on a supply and demand graph can be calculated as demand – supply. According to the above binding price ceiling graph, at the price of the $0.2 (ceiling price) demand is higher than the supply. Demand is 3 million of face masks and supply is 1 million of face masks. So, there is a shortage (demand exceeds the supply).
Shortage = Demand – Supply = 3-1 = 2 million of face masks
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Consumer and producer surplus with price ceiling
How to calculate consumer surplus with a price ceiling?
Consumer surplus after price ceiling equals to blue coloured area in above graph. It is comprised with a rectangular area and triangle area.
Consumer surplus = (Black market price – ceiling price)* quantity of supplied
Consumer surplus = (0.8 – 0.2) * 1 = $0.6 million
Consumer surplus = (maximum demand price – black market price) * quantity of supplied/2
Consumer surplus = (1 – 0.8) *1/2 = $0.1 million
Total amount of consumer surplus after price ceiling equals to $0.7 million ($0.1 million + $0.6 million).
How to calculate producer surplus with a price ceiling?
green coloured area in above graph equals to producer surplus after price ceiling.
producer surplus = (ceiling price – minimum supply price) * quantity of supplied /2
producer surplus = (0.2– 0) *1/2 = $0.1 million
the economic surplus is $0.8 million.
Economic surplus = producer surplus + consumer surplus
Economic surplus = 0.1 + 0.7 = $0.8 million
Deadweight loss of price ceiling
A deadweight loss is a cost to society created by market inefficiency, which occurs when supply and demand are out of equilibrium. In this price ceiling example, deadweight loss from price ceiling is presented in the pink coloured area. Also, the difference between economic surplus presents the deadweight loss of price ceiling.
Deadweight loss of price ceiling = Economic surplus before price ceiling – Economic surplus after price ceiling
Deadweight loss of price ceiling = 1 – 0.8 = $0.2 million
Black market price
In this situation some customers like to buy the face mask by paying a higher price than the ceiling price. Then suppliers are motivated to sell face marks at a higher price than the $0.2. Some times this price may be higher than the previously market price also ($0.4). This can be considered as a black market price. A black market price means the price which is higher or lower than the government implemented maximum or minimum prices. So, ceiling price of RM1.5 that is implemented by the government has become an only a legal price. Market price is higher than it.
According to above graph of price ceiling, the black-market price can be risen up to $0.8. $0.8 is the market price that relates to the 1 million of quantity of supply. Suppliers can sell the 1 million of face masks to the consumers under the $0.8 in the black-market. Because there is sufficient demand for face masks under this price. So, ultimately because of the price ceiling, some customers are not able to buy face masks while only some customers can buy face masks at the black-market price.
Tay, C. (2023). Price control creates long term distortions, say economists. [online] The Edge Markets. Available at: https://www.theedgemarkets.com/node/651258.
Astro Awani (2022). Moving away from price controls and subsidies. [online] Available at: https://www.dosm.gov.my/v1/uploads/files/5_Gallery/2_Media/4_Stats%40media/1_General%20News/2022/07.JULAI/26%20Julai-General%205-Astro%20Awani.pdf.