Price Controls: Ceilings and Floors
In one line. A binding price ceiling is a maximum price set below the equilibrium; it causes a persistent shortage, with rationing problems and black markets. A binding price floor is a minimum price set above the equilibrium; it causes a persistent surplus. Rent control, the minimum wage and agricultural support prices are the standard cases.
Exam relevance: a core A Level Economics topic, on ETG analysis of the last ten years. Taught the way an economics tutor who wrote the answer keys teaches it.
01What a price control is
A price control is a government limit on the price in a market, and whether it does anything at all depends on which side of the equilibrium it sits.
A price ceiling is a legal maximum price and a price floor is a legal minimum price. A control is binding only when it forces the price away from the free market equilibrium; a ceiling above equilibrium or a floor below it does nothing.
Because the controlled price is not allowed to move to clear the market, a binding control leaves a permanent gap between quantity demanded and quantity supplied, and that gap is the whole story of the topic.
02Price ceilings
A binding price ceiling is a maximum price set below the equilibrium, intended to keep a good affordable.
At the capped price, quantity demanded is high and quantity supplied is low, so demand exceeds supply. Because the price is held down by law, it cannot rise to ration the good, and the shortage persists.
03The effects of a binding ceiling
A persistent shortage forces some other mechanism to ration the good, and each of those mechanisms creates its own problems.
- Rationing problems. With price unable to ration, the good is allocated by queues, waiting lists or first come first served, which need not reach those who value it most.
- Black markets. Buyers unable to obtain the good legally pay more in an illegal resale market, so the price control is partly undone at a higher, untaxed price.
- Supply withdrawal. The low controlled price reduces the quantity firms are willing to supply, deepening the shortage over time.
Rent control on housing is the standard case: it lowers rents for those who hold a controlled flat but causes a housing shortage, less maintenance and a resale or sublet market.
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04Price floors
A binding price floor is a minimum price set above the equilibrium, intended to protect the incomes of sellers.
At the raised price, quantity supplied is high and quantity demanded is low, so supply exceeds demand. Because the price is held up by law, it cannot fall to clear the market, and the surplus persists.
05The effects of a binding floor
A persistent surplus has to go somewhere, and dealing with it is the cost of the floor.
A minimum wage is a price floor on labour: set above the equilibrium wage, the quantity of labour supplied exceeds the quantity demanded, which is a surplus of labour, or unemployment, among those who would have worked at a lower wage. An agricultural support price is a floor on a crop: the surplus output is often bought up by the government, so stocks build, and disposal or export is needed to clear it. In each case the floor protects sellers' incomes at the cost of a surplus that someone must absorb.
06Common misconceptions
A ceiling above the equilibrium and a floor below it are not binding and change nothing. State that the ceiling sits below, and the floor above, the free market equilibrium before claiming any shortage or surplus.
A second error is to treat the controlled price as a free market shortage that will self correct. It will not: the price is fixed by law, so the gap persists until the control is removed or the underlying demand or supply changes.
07Test yourself
- Using a diagram, explain why a binding price ceiling on rents causes a persistent housing shortage.
- Explain why a minimum wage set above the equilibrium can create unemployment.
- Why does a price floor above equilibrium lead to a surplus that the government may have to buy up?
Key terms on this page
Price ceilingPrice floorBinding price controlShortageSurplusBlack market
08Questions students ask
A price ceiling is a legal maximum price; to have any effect it is set below the equilibrium, and it causes a persistent shortage because quantity demanded exceeds quantity supplied. A price floor is a legal minimum price; to have any effect it is set above the equilibrium, and it causes a persistent surplus because quantity supplied exceeds quantity demanded.
Because a binding ceiling holds the price below the level that clears the market. At that lower price, quantity demanded rises and quantity supplied falls, so demand exceeds supply and the gap is a persistent shortage. Since the price is not allowed to rise to ration the good, the shortage does not self correct, which leads to queuing, rationing problems and black markets.
Rent controls are a price ceiling on housing, intended to keep rents affordable but causing housing shortages. A minimum wage is a price floor on labour, intended to protect incomes but able to create a labour surplus, or unemployment, if set above the equilibrium wage. Agricultural support prices are floors that produce crop surpluses the government often buys up.