Notes on Price Ceilings and Price Floors

Price Ceilings

A price ceiling is a legally imposed maximum price for a good or service. Sellers cannot charge above this limit. Governments use price ceilings to control the cost of essential goods and services. They aim to make these more affordable for consumers.

Effects of Price Ceilings

1. Positive Externalities: Price ceilings are often set on goods with positive externalities.
2. Demand and Supply: A lower price can lead to an expansion of demand while supply remains fixed.
3. Investment Limitations: Strict price caps can limit investment as they restrict the amount of profit a firm can make.

Pros

1. Affordability: Price ceilings make essential goods more affordable for consumers in the short term.
2. Consumer Protection: They protect the interests of consumers by keeping prices low.

Cons

1. Shortages: They can lead to long-term disadvantages like shortages of goods.
2. Reduced Supply: Lower prices may lead to a decrease in supply.

Price Floors

A price floor is a minimum price set by the government or a regulatory body. It prevents the price of a good or service from falling below a certain level. Price floors aim to protect vulnerable suppliers by imposing a minimum price on certain goods and services.

Effects of Price Floors

1. Supply and Demand: When set above the equilibrium price, a price floor will lead to excess supply, as the quantity supplied will exceed the quantity demanded.
2. Business Expansion: Higher prices and revenue for firms may encourage them to expand their business or invest further.

Pros

1. Producer Protection: Price floors protect the interests of producers by ensuring a minimum price for their goods.
2. Market Fairness: They can alleviate any unfair advantage to a market participant.

Cons

1. Surplus: They can lead to increased supply and reduced demand, creating a surplus.
2. Higher Prices: May lead to higher prices for consumers.