Price Control Mechanisms (Price Ceiling & Price Floor) Explained

Price control mechanisms explained. Pros and cons of Price Ceiling & Price Floor.

Introduction

A country’s standard of living depends on its ability to efficiently produce goods and services, and in general, trade is considered good and is always encouraged as it has the potential to make everybody better-off. In any market, there are buyers as well as sellers. Buyers will always prefer to pay less for products and services. Sellers on the other hand would prefer to sell their products for higher prices. One can see the impact of price on quantity demanded and supplied through the demand and supply curves. In most cases, the prices of the products are determined by the market forces, its usually based on supply and demand, and reaches the equilibrium point at some time. However, it’s possible for external forces to influence the market prices.

So, for example, the government can intervene to improve market outcomes, to achieve specific goals. The government may implement price controls in order to manage certain aspects of the economy by direct intervention. Because Governments have the power to intervene and affect market prices, they have to evaluate whom to support for the same cause. Most of the time, the government aims for social equity, if at all they have to intervene; the government implements price-control measures as a means of direct economic intervention to make certain products more affordable.

So, as mentioned in the requirement, the Government might intervene to make certain things more affordable to the masses, as in this case, to ensure critical medical equipment are available to the masses at an affordable price. Similarly, the Government might try to introduce initiatives in order to increase minimum wage rate to support unskilled and unorganized workers to facilitate their standard of living.

The government tries to achieve these objectives by using price control initiatives, which it might enforce through legislation. Two commonly used price control initiatives are Price Ceiling and Price Floor.

Price Ceiling & Price Floor

Price Ceiling refers to the legal maximum price for any product, and is commonly applied to essential items when such goods become unaffordable to the masses. Price Floor, on the other hand, refers to the Legal min price for any product, but it is commonly applied to wages, prices and interest rates.

While the government could impose both a price ceiling and a price floor, it usually only imposes either a ceiling or a floor for particular goods or services.

So, the government may introduce a Price Ceiling for some essential products. Introducing a price ceiling will prevent suppliers from overcharging for the product.

On the other hand, the government can introduce a Price Floor (for minimum wages), which means that the market cannot cause the prices to fall down below a particular level. This is to increase minimum wage rate to support unskilled and unorganized workers to improve their standard of living.

Price floor is also applied to products to prevents its widespread consumption. For example, the government might establish a price floor for tobacco with the intention of lowering consumption for health reasons. Without a price floor, the free market equilibrium price might be much lower due to more demand.

Challenges

While price controls may be enacted by the government with the intention of helping a certain section of the society, what has been observed in the past is that such measures in actual practice do not provide the desired benefits. And the main reason for that is any attempts to control prices often struggle to overcome the economic forces of supply and demand in the long-run. Despite the best intentions, price controls are usually ineffective in the long-run and usually provide the benefits only in the short-term.

In a free market, the prices keep on shifting and are determined by supply and the demand. However, when price controls are introduced by the government, it often creates excess demand (in the case of price ceilings), or excess supply (in the case of price floors), thus making the market inefficient.

Price controls enforced in the long run can lead to issues such as shortage of products as suppliers may cut down production, it could cause introduction of inferior quality products in the market, and can even encourage black marketers. Price controls eventually led to shortages in supply, and one will find long queue of buyers to buy the products causing a lot of inconvenience to buyers.

Price floors in wages, on the other hand, can give rise to other challenges. As the minimum wages of workers rise, the market may reject low-skilled workers causing more unemployment among low-skilled workers. Also, more thought should be given to how much the appropriate minimum wage should be, because in the long run, inflation will cause a loss in buying power and the workers may not see any noticeable change in buying power even after increased wages.

So, while these pricing controls are not really effective and can be detrimental to the economy in the long-run, politicians do use these pricing controls as they are also interested in solving short-term problems, including current social problems that will help them garner support, at least temporarily.

Price Ceiling

Price Ceiling is a fiscal policy used by the Government to intervene in the market to protect the interest of the consumers, by setting the maximum price the suppliers can charge for a commodity or service. It is a binding price ceiling below the equilibrium market price.

Price Ceiling can be both above or below the equilibrium price but a price ceiling above the equilibrium is rendered ineffective. Therefore, A price ceiling above the equilibrium price is non-binding.

However, price ceiling in long can lead to black marketing and unrest in the supply side.

RENT CONTROL ​is a prominent price ceiling policy used by GOI. The government can fix the maximum price a landlord can charge a tenant, this ensures the quality and affordability of houses in the rental market. This helps people in lower-income groups to afford houses in Cities that have better job opportunities However, Rent Control decreases the availability of apartments because the suppliers are unwilling to charge lower rents for their property. This practice discourages the supplier to invest in the maintenance of the property furthermore causing a reduction in the quantity and quality of the housing available. Thus, In the long run, Rent control leads to people being homeless.

ANALYSIS

To understand the concept of Rent Control with the help of the Demand-Supply curve, Let’s consider the above graph. SO the Y-axis represents the Rent charged by Landlords and the Xaxis represents the availability of the houses. As through the demand and supply interaction, we can see that the equilibrium price is at 3 units, but if the government thinks that this price is unfair, they might impose Price Ceiling below the equilibrium price, Here at 2 units, where we can see that Qd is 40 units and Qs is 20, which clearly shows a shortage of supply, this causes disequilibrium in the market.

PRICE CEILING ON UBER, ​as uber algorithm uses demand of cabs to decide the surge prices on the fare to set new equilibrium by reducing the demand. The Government of India lately surpassed a law that permits to set limits on how much Uber can price riders during peak times. This might create a shortage of cabs, longer waiting times, and deadweight loss. The cause of the better surge rate was to drivers’ opportunity cost of going out and driving around for higher than the money they wish to make, but now due to the fee ceiling, they won’t be willing to absorb rides with shorter distances.

PRICE FLOORING

Price Floor is another price control policy used by the government, but here the motive is to protect the interest of the suppliers, the government intervenes when they think that the price paid for the commodity is low.

The government defines the minimum legal price which should be charged for a commodity or service. Usually, Price Floor is used by the government to ensure that the farmers and laborers are getting fair prices.

For a Price Floor to be effective, the price must be above the equilibrium price like represented on the picture in the left. Prolonged Price Flooring can cause distress for the people it plans to support.

MINIMUM WAGE​ is an important tool used in the labor-wage market. Many countries like India have laws passed to determine the minimum to be paid to the workers, this helps the government ensure a better standard of living for the workers. However, looking at the economic implications of this aspect, we get contradicting outcomes. As we can see in the graph above that if the price is set above the equilibrium price, there is an excess supply of laborers, thus giving bargaining power to the employer but as this power cannot be used to charge less, the employers start hiring workers on the basis of the skill set and make them work for longer durations without paying extra, this throws away the low skilled workers out of the market as employers are typically not willing to pay more than the value addition brought in by the workers. This means that unskilled workers would have a hard time finding a job.

ANALYSIS

To understand the concept of Minimum Wagel with the help of the Demand-Supply curve, Let’s consider the above graph. SO the Y-axis represents the wage paid by employers and the Xaxis represents the number of laborers. With the help of demand and supply interaction, we can see that the equilibrium wage is at 3 units, but if the government thinks that this wage rate is unjust, they might impose Price Flooring above the equilibrium price, Here at 4 units, where we can see that Qd is 20 units and Qs is 40, which clearly shows an excess supply, this causes disequilibrium in the market.

PRICE FLOORING FOR AGRICULTURAL PRODUCTS ​is also used by the government to protect farmers from exploitation from wholesalers and agents. However, a price floor can hurt society more than it helps. Even though it helps farmers, It causes market inefficiencies as the market was efficient prior to the introduction of a price floor, price floors can cause a deadweight​ ​weight loss because of the deficiencies created due to the inefficient allocation of resources. Consumers may not be willing to pay higher prices for the exact same good therefore, they reduce their ​demand​ of the product. Meanwhile, suppliers find they are guaranteed a higher price than before so as to capitalize on this opportunity they increase their production. This creates excessive supply, in such cases, the government ends up buying and stockpiling the extra quantity or starts to subsidize consumption to encourage demand. However, the government destroys the surplus or allows it to spoil or the government sells the surplus in the market which would lead to fall in price furthermore causing market failure.

Summary

To summarize, whenever the prices go above or below the equilibrium price, the market forces put pressure on it and make it move towards equilibrium. However, the Government has the power to regulate the market and impact the pricing; they often use price control measures as part of policymaking. Measures like Price Ceiling and Price Floor are commonly used to create an impact on the market, often to prevent the prices of essential commodities to become very costly, and to prevent the prices of certain things drop below a particular point. However, it’s important to know that such regulations make the market less efficient; the market as a whole works much more efficiently if there are no restrictions.

References

Price controls – Principles of Microeconomics. (n.d.). Retrieved from https://pressbooks.bccampus.ca/uvicecon103/chapter/4-6-price-controls/