11/12/24, 9:29 AM Price Ceiling: Effects, Types, and Implementation in Economics

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LAWS & REGULATIONS SEC

Price Ceiling: Effects, Types, and

Implementation in Economics
By TROY SEGAL Updated August 08, 2024
Reviewed by CAITLIN CLARKE

Fact checked by PATRICE WILLIAMS

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.

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11/12/24, 9:29 AM Price Ceiling: Effects, Types, and Implementation in Economics

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

KEY TAKEAWAYS
A price ceiling is a type of price control that's usually government-
mandated and sets the maximum amount a seller can charge for a
good or service.
Price ceilings are typically imposed on consumer staples like food, gas,
or medicine, often after a crisis or particular event sends costs
skyrocketing.
The opposite of a price ceiling is a price floor, a point below which
prices can't be set.
Price ceilings make staples affordable for consumers in the short term
but they often carry long-term disadvantages such as shortages, extra
charges, or lower-quality products.
Economists worry that price ceilings cause a deadweight loss to an
economy, making it more inefficient.

Price Ceiling
Investopedia / Paige McLaughlin

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.

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11/12/24, 9:29 AM Price Ceiling: Effects, Types, and Implementation in Economics

A good may experience an unexpected shortage. The regulators may decide

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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.

Examples of Price Ceilings

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

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11/12/24, 9:29 AM Price Ceiling: Effects, Types, and Implementation in Economics

Rent Ceilings
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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. [1]

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.

FAST FACT
Rent control tenants in New York City are generally in buildings that
were built before Feb. 1, 1947, and where the tenant was in
continuous occupancy before July 1, 1971. Rent stabilization
applies to buildings of six or more units built between Feb. 1, 1947,
and Dec. 31, 1973. [2] [3]

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
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11/12/24, 9:29 AM Price Ceiling: Effects, Types, and Implementation in Economics

German government pledged to cap energy prices due to the shortage of

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Russian natural gas following the Russian invasion of Ukraine in 2022. [4]

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. [5]

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. [6]

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: [7]

NBA Collective Bargaining Agreement, Select Section

NBA Collective Bargaining Agreement, Select Section.

Price Ceiling vs. Price Floor

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11/12/24, 9:29 AM Price Ceiling: Effects, Types, and Implementation in Economics

A price floor is the opposite of a price ceiling. It sets a minimum purchase cost
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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.

Important: A minimum wage is a familiar type of price floor. It

operates on the premise that someone working full-time ought to
earn enough to afford a basic standard of living and 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 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.

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11/12/24, 9:29 AM Price Ceiling: Effects, Types, and Implementation in Economics

Types of Price Ceilings

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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
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
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11/12/24, 9:29 AM Price Ceiling: Effects, Types, and Implementation in Economics

ceilings can also stimulate demand and encourage spending.

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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.

Pros
• Keeps prices affordable
• Prevents price-gouging
• Stimulates demand

Cons
• Often causes supply shortages
• May induce loss of quality, corner-cutting
• May lead to extra charges or boosted prices on other goods

Gas Price Ceilings of the 1970s

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. [8]

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11/12/24, 9:29 AM Price Ceiling: Effects, Types, and Implementation in Economics

Shortages developed and rationing was often imposed as supplies fell short of
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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. [9]

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. [10]

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.

What Does Price Ceiling Mean?

A price ceiling, also referred to as a price cap, is the highest price at which a
good or service can be sold. It's a type of price control and it sets the maximum
amount that can be charged for something. It's often imposed by government
authorities to help consumers when it seems that prices are excessively high or
rising out of control.

What Are Some Price Ceiling Examples?

Rent controls are an example of a price ceiling. They limit how much landlords
can charge monthly for residences and how much they can increase rents. Caps
on the costs of prescription drugs and lab tests are another example of common
price ceilings and insurance companies often set caps on the amount they'll
reimburse a doctor for a procedure, treatment, or office visit.

What Is a Price Ceiling and Price Floor?

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11/12/24, 9:29 AM Price Ceiling: Effects, Types, and Implementation in Economics

Price ceilings and price floors are two types of price controls. They're opposites,
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as their names suggest. A price ceiling puts a limit on how much you have to
pay or how much you can charge for something. It sets a maximum cost,
keeping prices from rising above a certain level. A price floor establishes a
bottom-line benchmark. It keeps a price from falling below a particular level.
How Do You Calculate a Price Ceiling?
Governments typically calculate price ceilings that attempt to match the
supply-and-demand curve at an economic equilibrium point for the product or
service in question. They impose control within the boundaries of what the
natural market will bear. However, the price ceiling itself can impact the supply
and demand of the product or service over time. The calculated price ceiling
may result in shortages or reduced quality in such cases.

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.

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