WHAT ARE THE EFFECTS OF PRICE CEILINGS AND PRICE
FLOORS?
Bhakti Joshi
08 Nov, 2013
Definition: Price ceilings is the maximum price for a specific good established by the government which is
usually lower than the free market equilibrium price. On the other hand, price floors is the minimum price
for a particular good established by the government which is usually higher than the free market price.
In other words: Price ceilings give the sellers a maximum price to sell the product while price floors give
the sellers a minimum price to sell the product.
Why is this important?: Government could change the consumer surplus and producer surplus by
making price ceilings and price floors. They are a major tool that the government will use to intervene the
market.
Main notes:
Price Floor: We will use the market for butter in Europe to discuss the price floor.
First, given the supply and demand curve of free butter market in Europe, we could get equilibrium price
and quantity as Pe and Qe, which is the intersection of demand and supply curve. The price floor is usually
set higher(Pf in this example) than the equilibrium price of the good, which means the price floor is used to
help producers. In this butter market example, since the price is set at Pf, the production of the good will
increase to Qs and the demand of the good will decrease to Qd which means there will be surplus of butter
and we will have disequilibrium market for butter. Before the price floor, the total surplus of consumer and
producer is the whole colored area, where the area above Pe is consumer surplus and the area below the
Pe is producer surplus. But after the price floor, consumer will buy only Qd butter but at a higher price Pf.
Therefore, the consumer surplus decrease to the yellow area and the producer surplus increases to the
blue area. The total surplus also decreases. The purple area is the decreased total surplus, which is
regarded as deadweight loss.
To conclude, the effect of price floor is as follows:
1.
2.
3.
4.
5.
6.
7.
8.
higher price
lower demand
higher quantity supplied
surplus of butter
less consumer surplus
more producer surplus
deadweight loss
inefficiency in the market
Economics > High School Micro/Macro > Micro - Market Failure & Price Controls
Page 1 of 3
WHAT ARE THE EFFECTS OF PRICE CEILINGS AND PRICE
FLOORS?
Bhakti Joshi
08 Nov, 2013
Price ceilings:
Price ceiling: We will use the market for petrol in China to discuss the price ceiling effect.
Also, given the demand curve and supply curve of petrol market in China, we could identify the free
market equilibrium for petrol in China, Pe and Qe. If the government imposes a lower price, say Pc, under
the free market equilibrium price. Then the demand from petrol consumer in China will increase to Qd and
the supply of petrol will decrease to Qs. Therefore, we have a disequilibrium market for petrol and the
quantity demand is more than the quantity supplied which means a shortage. When it comes to the
consumer and producer surplus, similar to the price floor, the consumers are better off since they could
get the petrol at a lower price and the producers are worse off since they sell less petrol and at a lower
price. The yellow area is the new consumer surplus while the blue area is the new producer surplus and
the purple area is dead weight loss.
To conclude, the effect of price ceiling is as follows:
1.
2.
3.
4.
5.
6.
7.
lower price
higher demand
lower quantity supplied
shortage of petrol
more consumer surplus
less producer surplus
deadweight loss
Economics > High School Micro/Macro > Micro - Market Failure & Price Controls
Page 2 of 3
WHAT ARE THE EFFECTS OF PRICE CEILINGS AND PRICE
FLOORS?
Bhakti Joshi
08 Nov, 2013
8. inefficiency in the market
We could see from the analysis of price floor and price ceiling that although the transfer is different but
they all arise deadweight loss and inefficiency of the market.
Economics > High School Micro/Macro > Micro - Market Failure & Price Controls
Page 3 of 3