Price Ceiling Types, Effects, and Implementation in Economics

What Is a Price Ceiling?

A price ceiling is the mandated maximum amount a seller is allowed to charge for a product or service. Usually set by law, price ceilings are typically applied to staples such as food and energy products when such goods become unaffordable to regular consumers.

A price ceiling is essentially a type of price control. Price ceilings can be advantageous in allowing essentials to be affordable, at least temporarily. However, economists question how beneficial such ceilings are in the long run.

How a Price Ceiling Works

Price ceilings are implemented when a regulator sets a maximum price they believe is acceptable or appropriate. All sellers must offer their products at a price equal to or below that amount, and the sale of goods (in addition to how companies offer their products) is regulated and monitored.

Regulators also review the price ceiling regularly to ensure it still represents an appropriate level. These regulators perpetually evaluate market supply and demand to best understand whether the price ceiling needs to be increased or decreased. Consider an example where a good may experience an unexpected shortage. In this case, the regulators may decide a price ceiling may negatively influence producers or be impacting product quality, thus necessitating the removal of the ceiling.

While price ceilings might seem to be an obviously good thing for consumers, they also carry long-term ramifications. Certainly, costs go down in the short run, which can stimulate demand. However, producers need to find some way to compensate for the price (and profit) controls. They may ration supply, cut back on production or production quality, or charge extra for (formerly free) options and features. As a result, economists wonder how efficient price ceilings can be at protecting the most vulnerable consumers from high costs or even protecting them at all.

A broader and more theoretical objection to price ceilings is that they create a deadweight loss to society. This describes an economic deficiency, caused by an inefficient allocation of resources, that disturbs the equilibrium of a marketplace and contributes to making it more inefficient.

Real-World Cases of Price Ceilings

There are several instances of government-enforced price ceilings, usually for goods that are considered essential or necessary. The following are some common examples of price ceilings.

Rent Ceilings

Some areas have rent ceilings to protect renters from rapidly climbing rates on residences. Such rent controls are a frequently cited example of the ineffectiveness of price controls in general and price ceilings in particular.

In the late 1940s, rent controls were widely implemented in New York City and throughout New York State. In the aftermath of World War II, homecoming veterans were flocking and establishing families—and rent rates for apartments were skyrocketing, as a major housing shortage ensued. The original post-war rent control applied only to specific types of buildings. However, it continued in a somewhat less restricted form, called rent stabilization, into the 1970s.

The aim was to help maintain an adequate supply of affordable housing in the cities. However, the actual effect, critics say, has been to reduce the overall supply of available residential rental units in New York City, which in turn has led to even higher prices in the market.

Further, some housing analysts say, controlled rental rates also discourage landlords from having the needed funds, or at least committing the necessary expenditures, to maintain or improve rental properties, leading to deterioration in the quality of rental housing.

Food and Fuel Price Caps

Some governments may cap the prices of essential goods, such as food and fuel, in order to ensure access to these essential goods and prevent profiteering. For example, following the Russian invasion of Ukraine, the German government pledged to cap energy prices due to the shortage of Russian natural gas.

Cost Caps for Prescription Drugs and Laboratory Tests

In the United States, there is a strong incentive by medical equipment and drug manufacturers to raise prices, knowing that the increased cost will most likely fall on taxpayers or insurance companies. In order to prevent further price rises, president Biden signed the Inflation Reduction Act, which includes price caps on the negotiated prices of certain drugs.

Rideshares

As popularity of Uber and other rideshare services proliferated, these rideshare services could charge much higher fares during peak hours. This price variability concerned India, and the Karnataka government decided to implement the price per kilometer Uber and other rideshares could charge. In the long-run, the government noted that even though more passengers demonstrated interest in using rideshare services, passengers often needed to wait longer to get an Uber because fewer drivers were incentivized.

Salary Cap

Popular in professional sports, price ceilings may relate to the maximum amount a single employee may receive in compensation. Consider the agreement between the National Basketball Association and the National Basketball Players Association. The collective bargaining agreement between the two associations outlines a number of situations where a player is eligible to receive a maximum salary. Below is a snipped for newer players in the league with less than seven years of service.

Price Ceiling vs. Price Floor

The opposite of a price ceiling is a price floor, which sets a minimum purchase cost for a product or service. Also known as “price support,” it represents the lowest legal amount at which a good or service may be sold and still function within the traditional supply and demand model.

Both floors and ceilings are forms of price controls. Like a price ceiling, a price floor may be set by the government or, in some cases, by producers themselves. Federal or municipal authorities may actually name specific figures for the floors, but often they operate simply by entering the market and buying the product, thus propping its prices up above a certain level.

Many countries periodically impose floors on agricultural crops and products, for example, to mitigate the swings in supply and farmers' income that can commonly occur, due to factors beyond their control.

Effects of Price Ceilings

Although price ceilings are intended to ensure access to the most essential goods, they may sometimes have the counterintuitive effect of making those goods less accessible. This is because the government-enforced price does not reflect the market forces of supply and demand.

For example, many municipal governments enforce policies that limit raises in rental prices, in order to keep housing more affordable. This means that landlords are unable to raise rents when housing is in short supply. Because of these restrictions, developers are less likely to fund new developments, because their profits will be limited by existing rent controls. As a result, the supply of housing is less likely to increase in those cities, even when there is a shortage.

Types of Price Ceilings

Depending on the good being regulated and the entity doing the regulating, there are several types of price ceilings that governments can implement. Below is a list of the more common types of price ceilings.

• Absolute Price Ceiling: This is a fixed limit on the price that can be charged for a good or service. The price cannot go higher than this limit. A government can vote or decide to periodically change the absolute price ceiling, though these ceiling limit changes are often infrequent to uphold the usefulness of the regulation.
• Relative Price Ceiling: This is a limit on the price of a good or service in relation to another good or service. For example, a government might set a relative price ceiling on the price of rent in relation to the average income of renters in a particular area. In this example, the government would closely monitor the independent variable to better understand how the dependent variable's price ceiling fluctuates.
• Per Unit Price Ceiling: This is a limit on the price of a good or service per unit. For example, a government might set a per unit price ceiling on the price of gasoline. This type of price ceiling is similar to the absolute price ceiling, though a consumer could theoretically spend as much as they want if they were to buy higher amounts of quantities.
• Periodic Price Ceiling: This is a limit on the price of a good or service for a specific period of time. For example, a government might set a periodic price ceiling on the price of electricity during the summer months when demand is high. Governments may enact periodic price ceilings during times of emergency
• Selective Price Ceiling: This is a limit on the price of a specific type of good or service. For example, a government might set a selective price ceiling on the price of prescription drugs to make them more affordable for consumers.

Advantages and Disadvantages of Price Ceilings

The big pro of a price ceiling is, of course, the limit on costs for the consumer. It keeps things affordable and prevents price-gouging or producers/suppliers from taking unfair advantage of them. If it's just a temporary shortage that's causing rampant inflation, ceilings can mitigate the pain of higher prices until supply returns to normal levels again. Price ceilings can also stimulate demand and encourage spending.

So, in the short term, price ceilings have their advantages. They can get to be a problem, though, if they continue too long, or when they are set too far below the market equilibrium price (when the quantity demanded equals the quantity supplied). 

When they do, demand can skyrocket, leading to shortages in supply. Also, if the prices producers are allowed to charge are too out of line with their production costs and business expenses, something will have to give. They may have to cut corners, reduce quality, or charge higher prices on other products. They may have to discontinue offerings or not produce as much (causing more shortages). Some may be driven out of business if they can't realize a reasonable profit on their goods and services.

Example of a Price Ceiling

In the 1970s, the U.S. government imposed price ceilings on gasoline after some sharp rises in oil prices. As a result, shortages quickly developed. The regulated prices seemed to function as a disincentive to domestic oil companies to step up (or even maintain) production, as was needed to counter interruptions in oil supply from the Middle East.

As supplies fell short of demand, shortages developed and rationing was often imposed through schemes like alternating days in which only cars with odd- and even-numbered license plates would be served. Those long waits imposed costs on the economy and motorists through lost wages and other negative economic impacts.

The supposed economic relief of controlled gas prices was also offset by some new expenses. Some gas stations sought to compensate for lost revenue by making formerly optional services such as washing the windshield a required part of filling up and imposed charges for them.

The consensus of economists is that consumers would have been better off in every respect had controls never been applied. If the government had simply let prices increase, they argue, the long lines at gas stations would never have developed. Oil companies would have bumped up production, due to the higher prices, and consumers, who now had a stronger incentive to conserve gas, would have limited their driving or bought more energy-efficient cars.

The Bottom Line

Price ceilings prevent a price from rising above a certain level. They are a form of price control. While in the short run, they often benefit consumers, the long-term effects of price ceilings are complex. They can negatively impact producers and sometimes even the consumers they aim to help, by causing supply shortages and a decline in the quality of goods and services.