Page 41 - DECO405_MANAGERIAL_ECONOMICS

Managerial Economics

Notes Price Ceiling and Price Floors

A price ceiling occurs when the price is artificially held below the equilibrium price and is not
allowed to rise. There are many examples of price ceilings. Most price ceilings involve the
government in some way.

Example: In many cities, there are rent controls. This means that the maximum rent that
can be charged is set by a governmental agency. This rent is usually allowed to rise a certain
percent each year to keep up with inflation. However, the rent is below the equilibrium rent.
If the price ceiling is above the market price, then there is no direct effect. If the price ceiling is
set below the market price, then a “shortage” is created; the quantity demanded will exceed the
quantity supplied. The shortage may be resolved in many ways. One way is “queuing”; people
have to wait in line for the product, and only those willing to wait in line for the product will
actually get it. Sellers might provide the product only to family and friends, or those willing to
pay extra “under the table”. Another effect may be that sellers will lower the quality of the good
sold. “Black markets” tend to be created by price ceilings.
Figure 3.3 depicts the effect of price ceiling and price floor.
Figure 3.3: Price Ceiling and Price Floor

A price floor exists when the price is artificially held above the equilibrium price and is not
allowed to fall. There are many examples of price floors. In some cases, private businesses
maintain the price floor while, in other cases, it is the government that maintains the price floor.
One price floor that was maintained by the private businesses used to be called “fair trade”. In
the case of fair trade, the manufacturer would set a price for the product that was above the
equilibrium price. The manufacturer then told the retail stores that the price could not be
lowered or the store would not be able to sell any of the manufacturer’s products.
When a “price floor” is set, a certain minimum amount must be paid for a good or service. If the
price floor is below a market price, no direct effect occurs. If the market price is lower than the
price floor, then a surplus will be generated. Minimum wage laws are good examples of price
floors.

Task Give examples from real life situations, where a price ceiling or price floor
has been imposed.

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