Price Ceiling

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

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.

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.

In New York City, rent control tenants are generally in buildings built before Feb. 1, 1947, where the tenant is in continuous occupancy prior to July 1, 1971. Rent stabilization applies to buildings of six or more units built between February 1, 1947, and Dec. 31, 1973.

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.

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.

A minimum wage is a familiar type of price floor. Operating on the premise that someone working full time ought to earn enough to afford a basic standard of living, it sets the lowest legal amount that a job can pay.

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.

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, reducing 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 may never have developed, and the surcharges never imposed. 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.

Price Ceiling FAQs

What Does Price Ceiling Mean?

A price ceiling, aka a price cap, is the highest point at which goods and services can be sold. It is a type of price control and the maximum amount that can be charged for something. It often is set by government authorities to help consumers, when it seems that prices are excessively high or rising out of control.

What Are Price Ceiling Examples?

Rent controls, which limit how much landlords can charge monthly for residences (and often by how much they can increase rents) are an example of a price ceiling.

Caps on the costs of prescription drugs and lab tests are another example of a common price ceiling. In addition, insurance companies often set caps on the amount they'll reimburse a doctor for a procedure, treatment, or office visit.

What Is Price Ceiling and Price Floor?

Price ceilings and price floors are the two types of price controls. They do the opposite thing, as their names suggest. A price ceiling puts a limit on the most you have to pay or that you can charge for something — it sets a maximum cost, keeping prices from rising above a certain level.

A price floor establishes a minimum cost for something, a bottom-line benchmark. It keeps a price from falling below a particular level.

How Do You Calculate a Price Ceiling?

Governments typically calculate price ceilings that attempt to match the supply and demand curve for the product or service in question at an economic equilibrium point. In other words, they try to impose control within the boundaries of what the natural market will bear. However, over time, the price ceiling itself can impact the supply and demand of the product or service. In such cases, the calculated price ceiling may result in shortages or reduced quality.

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.