Price Ceiling

A price ceiling is a government-imposed limit on the price charged for a product. Governments intend price ceilings to protect consumers from conditions that could make necessary commodities unattainable. However, a price ceiling can cause problems if imposed for a long period without controlled rationing. Price ceilings can produce negative results when the correct solution would have been to increase supply. Misuse occurs when a government misdiagnoses a price as too high when the real problem is that the supply is too low. In an unregulated market economy price ceilings do not exist. Students may incorrectly perceive a price ceiling as being on top of a supply and demand curve when in fact; an effective price ceiling is positioned below the equilibrium position on the graph.
Effects of Price Ceilings
Binding Versus Non-Binding price ceilings
A price ceiling can be set above or below the free-market equilibrium price. For a price ceiling to be effective, it must differ from the free market price. In the graph at right, the supply and demand curves intersect to determine the free-market quantity and price. The dashed line represents a price ceiling set above the free-market price, called a non-binding price ceiling. In this case, the ceiling has no practical effect. The government has mandated a maximum price, but the market price is established well below that. In contrast, the solid green line is a price ceiling set below the free market price, called a binding price ceiling. In this case, the price ceiling has a measurable impact on the market.
Consequences of Binding Price Ceilings
A price ceiling set below the free-market price has several effects. Suppliers find they can't charge what they had been. 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