PRICE CEILINGS 1
Cedric Chehab
30 Dec, 2013
Definition- The maximum price a seller is allowed to charge for a product or service. Price ceilings are
usually set by the government in order to ensure fair business practice. The price ceilings result is
something known as either a binding or non binding price ceiling.
In Other Words- Price ceilings are designed to protect low income individuals, so they can afford
important (necessities) resources. The government intervenes and sets up limits as to what employers
can and cannot charge.
Why is This Important? It prevents businesses from taking advantages of loopholes in the system. For
example, suppose a major hurricane wipes out all electricity in a town for a week. From a
producer's standpoint, they may attempt to increase prices in oil because demand for it will suddenly be
greater. The government has price ceiling’s in place, so businesses cannot take advantage of such
situations.
Price Ceilings are not always accurately set by the government, which leads to binding and nonbinding
price ceilings.
Binding and Nonbinding price ceilings: A price ceiling is binding when it is set below the equilibrium
price. A non binding price ceiling is when it is set above the equilibrium price. This means that it is the
legal maximum or minimum price the government has set for a variety of reasons.
Binding Price Ceiling Example: Demand for tickets for an NFL game suddenly greatly increase because
of a huge rivalry taking place. The government has set the binding price that NFL owners can charge for
tickets.
Under normal circumstances, equilibrium occurs when Supply = Demand, where you have P* and
Q*. Suppose there is a great increase in demand. This would normally lead to an increase in the price.
However, because of the price control, which is below the equilibrium price, a shortage will occur. This is
because, at that price, the producer will only sell a number of goods, yet there is lots of demand, you have
Qd and P ceiling, and a shortage.
Results from Shortage: Black markets will form (An illegal traffic or trade in officially controlled or
Economics > Microeconomic Principles > Price Controls & Taxes
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PRICE CEILINGS 1
Cedric Chehab
30 Dec, 2013
scarce commodities) and as a result, scalpers will be selling tickets for high prices. Since demand is so
great, people will pay for them.
Consequences/Aftermath: Suppliers find they can't charge what they had been charging before the
ceiling (or equilibrium price). As a result, some suppliers drop out of the market. This reduces supply.
Meanwhile, consumers find they can now buy the product for less, so quantity demanded increases. These
two actions cause quantity demanded to exceed quantity supplied, which causes a shortage.
Non Binding Price Increase: Essentially, has no effect on the market price. This is because the
maximum price is above the market price. This means that the equilibrium is under the price ceiling and
has no effect as supply and demand intersect. At that price, there is more supply than demand, and hence
a surplus.
Economics > Microeconomic Principles > Price Controls & Taxes
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