Price Ceilings
and
Price Floors
How market prices are
“distorted” by Government
Policies
SUPPLY/DEMAND AND GOVERNMENT POLICIES---PRICE
CEILINGS AND PRICE FLOORS
 In a free, unregulated market system, market forces establish equilibrium prices and
quantities.
 While equilibrium conditions may be efficient, not everyone will be satisfied with prevailing
market price (either too high or too low)
 Price controls are usually implemented when it is perceived that the market price is unfair
to either buyers OR sellers
SUPPLY/DEMAND AND GOVERNMENT POLICIES---PRICE
CEILINGS AND PRICE FLOORS
Price Ceiling
 A legal maximum on the price at which a good can be sold.
Price Floor
 A legal minimum on the price at which a good can be sold.
We are going to examine a PRICE FLOOR…
There are two prominent “real world” examples of Price Floors. One is the
“Minimum Wage” law and the other is the pricing-setting by government
of various agricultural commodities.
I am going to use the Example of Price Floors established by the
Government in the Agricultural Market(s)
SUPPLY/DEMAND AND GOVERNMENT POLICIES--PRICE CEILINGS AND PRICE FLOORS
Two outcomes are possible when the government imposes a price floor:
 The price floor is not binding if set below the equilibrium price.
 The price floor is binding if set above the equilibrium price, leading to a shortage
 We will look at a BINDING Price Floor and a NON-Binding Price Floor
Market for _________________
Price
Of
___
S*
“A”
Pe
Lets assume this market represents the
“Free” Market for Corn in the US and it is
in “normal” equilbrium at:
“Pe” and “Qe”---Point “A”
D*
Qe
Quantity of _____________
Market for _________________
Price
Of
___
S*
“A”
Pe
Assume the growers of Corn
Experience a bumper crop and
They harvest significantly more
Than they expected. In the
Market For Corn the SUPPLY of
Corn is Going to INCREASE.
The SUPPLY Curve will Shift to
D*
the RIGHT. (next slide)
Qe
Quantity of _____________
Market for _________________
Price
Of
___
S*
S
“A”
1
The Market Price
For Corn DECREASES
From “Pe” to “P1”.
Pe
“B”
P1
D*
Qe
Q1
This is NOT good for
farmers to receive a
Lower price than before.
It might cause financial
Hardships and some farmers
Might go out of business.
“SAVE THE “FAMILY” FARM!”
Quantity of _____________ Was the cry from the Heartland!
Market for _________________
Price
Of
___
S*
“A”
Pe
“B”
P1
D*
Qe
Q1
Quantity of _____________
S1
The Farm Lobby can lobby
Their favorite
Congressperson/Senator
and encourage the
imposition of a PRICE
FLOOR.
A PRICE FLOOR establishes
a MINIMUM price that the
good can be sold for.
It CANNOT be sold for
LESS!
Market for _________________
Price
Of
___
S*
S1
Assume the Government
sets the Price Floor at the
previous equilibrium price
Of “Pe”. (next slide)
“A”
Pe
“B”
P1
D*
Qe
Q1
Quantity of _____________
Market for _________________
Price
Of
___
S*
S
“A”
“C”
Pe = Price Floor
“B”
P1
D*
Qd
Q1
Qs
Quantity of _____________
1
If the Market Price is truly at
Point “B” and the government
sets the price at “Pe”, then the
Quantity Demanded at “Pe” is
at Point “A” (Demand Curve did
not shift) but the Quantity
Supplied is at Point “C” (Supply
curve shifted to the RIGHT).
Quantity Supplied is greater
than Quantity Demanded.
There will be a SURPLUS in the
market for Corn
(Seen on next slide)
Market for _________________
Price
Of
___
S*
“A” “SURPLUS”“C”
Qs - Qd
Pe = Price Floor
“B”
P1
D*
Qd
Q1
Qs
Quantity of _____________
S
1
The market wants to buy and sell at
Point “B” but the Price Floor
prevents it.
The Price Floor stays in place as
long as the Market price stays
BELOW the Price Floor of “Pe”. This
Price Floor is said to be BINDING
Farmers get paid an higher price
and the government takes
possession of the surplus and uses it
as (1) foreign food aid (2) Federal
School lunch programs.
However, the main result is
consumers of Corn pay a higher
price than they otherwise would
absent the PRICE FLOOR.
Market for _________________
Price
Of
___
S*
“A” “SURPLUS”“C”
Qs - Qd
Pe = Price Floor
“B”
P1
D*
Qd
Q1
Qs
Quantity of _____________
S
1
Now assume in the following
growing season the crop is a
disaster and the harvest is poor.
The Supply of Corn is going to
DECREASE at every price, hence
the Supply Curve will shift to
the LEFT.
This gets messy on the next
slide. I will clean it up on a
subsequent slide.
Market for _________________
S
Price
Of
___
2
S*
“D”
P2
“A” “SURPLUS”“C”
Qs - Qd
Pe = Price Floor
“B”
P1
D*
S
1
Told you, Messy! Notice the
Supply Curve (“S1”) shifted to
the LEFT (“S2”). We now have a
NEW Market Quilibrium Price
of “P2” and Quantity “Q2” at
Point “D”.
The NEW Price is ABOVE the
established PRICE FLOOR.
Q2
Qd
Q1
Qs
Quantity of _____________
Let me clean this up on the
next slide.
Market for _________________
S
Price
Of
___
2
S*
“D”
P2
“A”
Since the Martket Price is
above the minimum Price Floor
Farmer will be able to receive
the Market Price “P2” and not
the Price Floor “Pe”
Pe = Price Floor
D*
Q2
Qd
Quantity of _____________
The Price Floor now becomes
“NON-BINDING” at Point “D”
If the Market Price falls below
the Price Floor then the “Pe”
will become BINDING again.
Fun Stuff!