FLASH SALE! - "FINANCIAL MODELING COURSE BUNDLE AT 60% OFF" Enroll Now

Price Ceiling

Updated on February 23, 2024
Article byRutan Bhattacharyya
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A Price Ceiling?

Price ceiling refers to the government-imposed maximum limit set to the price of any product or service. The main purpose of this type of price control is to keep prices of essentials affordable at least for the time being, and safeguard consumers.  

Price Ceiling

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Price Ceiling (wallstreetmojo.com)

Typically, such limits apply to staples, like energy and food products, when these products become unaffordable for regular consumers. This measure taken by the government can be effective if the set limit is lower when compared to the natural equilibrium price. There are different types of this limit, for example, relative, absolute, and selective.

Key Takeaways

  • The price ceiling refers to the maximum price a seller can charge a buyer for a certain product or service. The government sets the price cap to safeguard consumers from rising prices of goods and services.
  • A key difference between price floor and ceiling is that the government typically sets the former to protect suppliers, not consumers.
  • There are various price ceiling benefits. For example, it promotes innovation and forces suppliers to utilize resources efficiently.
  • Consequences of price ceiling include higher consumer demand in the short run and shortages in the long run.

Price Ceiling Explained

The price ceiling refers to the maximum amount a seller can charge consumers for any product or service. The government sets this maximum price limit to ensure that prices do not rise above a specific level. This protects regular consumers as essentials can stay affordable because of the government-mandated price limit. That said, many economists question how advantageous such price control can be in the long run. Note that the limit is set at an amount that the regulator deems appropriate.

The regulators or governments keep reviewing the set limit regularly, ensuring the prices are still under control. Moreover, they perpetually assess supply and demand in the market to fully understand if they need to raise or lower the limit.

A theoretical and broad objection concerning this concept is that it can lead to a deadweight loss for society, which means an economic deficiency resulting from inefficient resource allocation. It disturbs the marketplace’s equilibrium, making contributions that increase its inefficiency.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Types

The different kinds of price ceilings can be as follows:

  • Relative: In this case, governments set a maximum limit on the price charged for any product or service by taking into account an independent variable. For example, governments may place a cap on the rent of houses in a specific area after considering the income of individuals in that particular area.
  • Per Unit: This is the cap on the price of goods on a per-unit basis. For example, the government may put a maximum limit on the price charged for petrol.  
  • Absolute: This refers to a specific cap set on the price charged for a product or service. Note that the price of a commodity cannot be higher than this maximum limit. Governments may decide to change the set limit periodically. However, they do not alter such limits frequently to ensure the regulation remains useful.
  • Selective: This refers to the cap set on a particular product or service’s price. For instance, governments might fix a selective limit on prescription drugs’ prices to ensure they remain affordable for regular consumers.
  • Periodic: In this case, the government limits the price of any service or product for a certain duration. One may observe this type of price control in emergency situations.

Examples

Let us look at a few price ceiling examples to understand the concept better.

Example #1

Suppose the prices of some medicines were increasing in Country A owing to the spread of a disease. To control drug prices and ensure that they remained affordable for regular consumers, the nation’s government set a periodic price ceiling. As a result, the price of the medicines could not exceed a specific amount for at least the next six months. As a result of the step taken by Country A’s government, even the individuals belonging to the low-income group of the population were able to get access to medication without incurring significant expenditures. The government increased the maximum limit after the six-month period to avoid shortages. 

Example #2

Bundesnetzagentur, the German Federal Network Agency, announced price ceilings for wind power as well as photovoltaic or PV tenders for 2024. The agency fixed the cap at €0.0737/kWh and €0.0735/kWh for ground-mounted PV systems and onshore wind farms, respectively. Moreover, Bundesnetzagentur set the price cap at €0.1050/kWh for rooftop PV. The purpose of setting such price limits was to establish a dependable framework for auctions. If the agency had not announced the new limits, the tenders’ ceiling prices would have dropped significantly per provisions issued previously this year.

Effects

After the imposition of a maximum limit, regular consumers who are able to buy the products at a decreased cost can largely benefit in the initial stages. That said, usually, the limit will increase the demand and lead to reduced supply, resulting in a shortage. Also, sellers may introduce extra charges to maintain profitability, maintain quality, and curb black market activity if the government introduces such a limit.

Thus, to sum it up, the main consequences of price ceiling are as follows:

  • Shortages will materialize in the long term.
  • Sellers may levy extra charges.
  • Prices will decrease in the short term only.

Pros And Cons

Let us look at the advantages and disadvantages of this concept.

#1 – Pros

  • It can safeguard vulnerable populations from significant price increases during any disaster.
  • Such a price limit can prevent monopolies from charging excessively high prices.
  • It can pressure organizations into allocating resources more efficiently and minimizing costs.
  • This type of cost control increases demand in the market.
  • Another key price ceiling benefit is that it can promote innovation.

#2 – Cons

  • The quantity demanded often exceeds the quantity supplied. This leads to shortages in the market.
  • Producers often degrade the quality of their products to reduce their costs and maintain profit margins.  
  • Black market activity can increase when consumers are ready to pay an amount higher than the legal price to get access to the product or service.

Price Ceiling vs Price Floor

People new to the concepts of price floor and ceiling may find it difficult to develop a clear understanding of their meaning and purpose. For them, it is vital to know the key differences. So, let us find out how these two differ.

Price CeilingPrice Floor
It is the maximum limit imposed on a commodity’s price.   Price floor refers to the lowest limit fixed by a government on the price of any price or service.
Typically, the government imposes this limit to protect consumers  A price floor generally aims to safeguard producers.
The maximum limit is below the equilibrium price.  In this case, the equilibrium price is below the lower price limit.  
It results in excess demand.The price floor leads to excess supply.

Frequently Asked Questions (FAQs)

1. How are price ceilings and price floors similar?

The key similarities between these two limits are as follows:
– Government or regulators set both of them.
– Both can result in a deadweight loss for society.
– Price floor and ceiling can impact consumer demand.
– The purpose of setting both is to safeguard certain groups in society.

2. Are price ceilings illegal in the United States?

No, they are not illegal in the United States. The government may set such limits to prevent malpractices concerning the price of goods and services and protect consumers.

3. Does the price ceiling increase consumer surplus?

Note that consumer surplus may rise or fall. The two factors determining the increase or decrease are the price ceiling’s height and the demand function.

4. Can price ceilings be effective in controlling inflation?

Yes, they can be a useful tool for governments to keep inflation in check and safeguard consumers by regulating the prices of goods and services.

This article has been a guide to what is a Price Ceiling. Here, we compare it with price floor, and explain its examples, effects, pros, cons, and types. You may also take a look at the useful articles below –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *