Price ceiling

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A price ceiling is a government imposed limit on how high a price can be charged on a product. Price ceilings are often intended to protect consumers from certain conditions that could make necessities unattainable. But they can also cause problems if they are used for a prolonged period of time without controlled rationing. Students may often incorrectly attribute a price ceiling as being on top of a supply and demand curve when in fact, an effective price floor is positioned above a supply and demand graph.

Contents 1 Effects of Price Ceilings 1.1 Binding Versus Non-Binding price ceilings 1.2 Consequences of Binding Price Ceilings 1.2.1 Reduction in quality 1.2.2 Black markets 1.2.3 Discrimination 2 Real World Examples 2.1 Rent Control in New York City 2.2 Coulter Law in VFL 2.3 State Farm Insurance 2.4 Venezuela 3 References 4 See also

[edit] Effects of Price Ceilings

[edit] 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.

[edit] Consequences of Binding Price Ceilings

A price ceiling set below the free-market price has several effects. Suppliers find they can no longer charge what they had been charging for their products. As a result, some suppliers drop out of the market. This represents a reduction in the quantity supplied. Meanwhile, consumers find that they can now buy the same product at a lower price. As a result quantity demanded increases. As a result of these two actions, quantity demanded exceeds quantity supplied and a shortage emerges, unless rationing or other forms of consumption controls are enforced.

This leads to various forms of non-price competition so that supply is able to meet demand.

[edit] Reduction in quality

In order to supply something like the required demand at the legal price, the most obvious thing that a seller is likely to do is to lower costs. However, in most cases lower costs will carry with them lower quality of product.

Examples of this can be seen during World War II when sellers of foods effected by price ceilings would:

1. reduce their size
2. use less expensive ingredients (fat instead of meat)

It can also be seen in the reduction in maintenance of apartments subject to rent control^[1].

There are scholars, however, who doubt that price ceilings necessarily drive quality down in the case of an oligopoly^[2]. It is argued that if there are very few competing firms, then to attract buyers a company at the lower end of the market under a price ceiling must find ways to achieve better quality without raising price.

[edit] Black markets

If somebody cannot obtain a good (s)he needs because a price ceiling reduces the quantity supplied, (s)he may turn to the black market to obtain the good. Those who by luck or good management obtain goods of which there is a shortage can make a profit by selling it illegally at a price higher than would be obtained on a free market. The black market price is higher than the free market price simply because the quantity supplied is less than would take place on a free market where more sellers could afford to sell the product.

[edit] Discrimination

If there is a shortage, the seller may choose to severely discriminate in who is able to buy from him or her. In the case of rent control in New York City, it is known that many celebrity actors and actresses have been able to obtain apartments at the controlled prices whilst other poorer people have been deliberately denied housing by landlords.

[edit] Real World Examples

[edit] Rent Control in New York City

Rent control is a price ceiling on rent. When soldiers were coming back from World War II and starting families (causing a large demand for apartments), but stopped receiving pay (there was no longer a war), many could not deal with the jumping rent. The government put in price controls, so the soldiers and their families were able to pay their rent and keep their homes. However, this increased the quantity demanded for apartments and lowered the quantity supplied, meaning that all available apartments were rapidly taken, until there were none left for any late-comers. Price ceilings create shortages when producers are allowed to abdicate market share or go unsubsidized.

[edit] Coulter Law in VFL

As a result of declining competitive balance following the admission of Footscray, Hawthorn and North Melbourne in 1925^[3][4], the VFL introduced a ceiling wage of £3 (around 160 Australian dollars at 2008 prices) in 1930. Known as the Coulter Law after George Coulter, it was varied several times before finally being abolished in 1968, being cut in half during World War II and increased in line with inflation after the war.

In its early years, the poorer clubs did not have the money to pay their players even the legal wage, and Melbourne preferred to give its players jobs rather than payments, but some clubs such as Richmond did pay above the legal wage.

The Coulter Law was a strictly binding price ceiling through its history mainly for top players such as Ron Todd, John Coleman and Brian Gleeson. In the case of Todd it led to him moving to the VFA because he was dissatisfied with the pay he could legally gain with Collingwood^[5], whilst Coleman and Gleeson were prevented from having surgery to continue their careers that they would have been able to have on higher wages.

[edit] State Farm Insurance

A February 4, 2009 Wall St. Journal article stated, "Last month State Farm pulled the plug on its 1.2 million homeowner policies in Florida, citing the state's punishing price controls... State Farm's local subsidiary recently requested an increase of 47%, but state regulators refused. State Farm says that since 2000 it has paid $1.21 in claims and expenses for every $1 of premium income received." ^[6]

[edit] Venezuela

A January 10, 2006 BBC article reported that since 2003, Venezuela President Hugo Chavez has been setting price ceilings on food, and that these price ceilings have caused shortages and hoarding.^[7] A January 22, 2008 article from Associated Press stated, "Venezuelan troops are cracking down on the smuggling of food... the National Guard has seized about 750 tons of food... Hugo Chavez ordered the military to keep people from smuggling scarce items like milk... He's also threatened to seize farms and milk plants..."^[8] On February 28, 2009 Chavez ordered the military to temporarily seize control of all the rice processing plants in the country and force them to produce at full capacity, which he alleged they had been avoiding in response to the price caps.^[9]

A January 3, 2007 article in the International Herald Tribune reported that Chavez's price ceilings were causing shortages of materials used in the construction industry. ^[10] According to an April 4, 2008 article from CBS News, Chavez ordered the nationalization of the cement industry, in response to the fact that the industry was exporting its products in order to receive prices above those which it was allowed to obtain within the country.^[11]

[edit] References

[edit] See also

• Price floor
• General equilibrium
• Black market