Price ceiling is a government-mandated limit on the price that can be charged for a given product, such as a utility or electricity.
The intended purpose of a price ceiling is to protect the consumers from conditions that would make a vital product from being financially unattainable for consumers.
Example of Price Ceiling
American soldiers returning from World War II found apartment costs in New York to be unaffordable.
As a result, the City of New York instituted a price ceiling on rent.
Prior to the return of the American soldiers, assume that apartments had been renting for $500 a month, and there was a demand for 600,000 apartments.
Now that the City of New York has imposed a price ceiling, by law, rent prices cannot exceed $400. At the lower price, demand obviously increases to 800,000 apartments.
Who benefits and who loses from a Price Ceiling in this example?
In the above example, renters benefited from this price ceiling, as they are now able to secure an apartment for $200 cheaper.
Landlords are the clear losers in this example, as they now receive $200 less in revenue per month.
Moreover, real estate developers might no longer have an incentive to build new properties since the money they bring in might not cover expenses.
Keep in mind that landlords might be forced to cutback on certain services that were previously offered to the tenants to reflect the lack of operating income such as heat or building maintenance.
Problems involving a Price Ceiling
For a price ceiling to be effective in its intended purpose, it obviously must differ from the currently established price.
For example, if a ceiling price is imposed which is higher then the current price, then there is no practical effect, making the Ceiling useless. This means that the government has dictated a maximum price, yet companies are currently selling the product below the ceiling.
Where this becomes an issue is on the opposite side, if the government set the price ceiling below the current market price. Consider a product that currently sells for $50, and the government imposes a legal limit of $45. Suppliers of the product are now legally forced to accept the lower prices, and sell the product for $5 below their target-selling price. The incentive to sell the product at the reduced price is reduced as it cuts into their profit margins, and they might chose to discontinue production. Consumers might then face a situation where there is a shortage of available products.
The government has put into place a legal maximum allowed price, but there are no laws preventing the supplier from completely scrapping the product, or changing their production quantities.
Moreover, suppliers of this product might be forced to reduce the quality of the product to compensate for their lost revenues. The consumer suffers in the end, as they now are forced to purchase a lower quality product.
Price ceilings are normally imposed during periods of, or directly following economic hardship, famine or war. The government needs to step in to establish a maximum price to prevent out of control increases in price.
Price ceilings are counter-productive in the sense that it dictates the maximum price that can be charged, while ignoring the price set by the market.
In the free market, buyers wish to minimize the price they are willing to pay, and sellers wish to maximize their revenues, hence both buyers and sellers compromise, and establish a price at which everyone is as satisfied as possible.
A price ceiling can have unintended consequence of ruining the free market by forcing suppliers to cut back on their product, produce inferior versions, or simply disband the product altogether.
Buyers now are faced with a potential shortage of the product and may even be forced to secure the product through illegal means, such as looking in to the black market.
Economists have a difficult time presenting a strong benefit to price ceilings, as a government imposed maximum price often goes against the free hand of the market.