3/12/12

What is a price ceiling? Examples of binding and non binding price ceilings


Price ceilings are common government tools used in regulating.  A price ceiling means that the price of a good or service cannot go higher than the regulated ceiling.  Imagine a balloon floating in your house, the balloon cannot go higher than the ceiling.  The same concept holds with prices and a price ceiling.  The price cannot go higher than the price ceiling.  Where this gets tricky is that a BINDING price ceiling occurs BELOW the equilibrium price.  It may be confusing to have a ceiling below something, but if you think it through it makes sense.  If a balloon wants to float to 50 meters, than the ceiling must be below 50 meters in order to be effective.  If the ceiling is at 100 meters, the balloon (price) can rise to 50 meters with no problem.


Economics classes want students to be able to recognize the difference between binding and non binding price ceilings.  Consider the example of a price ceiling for apartments in New York.  If the equilibrium price is $2,000 per month, and the government sets a price ceiling of $3,000 per month, is anything going to happen?  The answer is no, because everyone who is willing to pay up to $2,000 gets an apartment, and everyone who is willing to supply an apartment for $2,000 gets paid.  This is an example of a non binding (or not effective) price ceiling. 

Note that the price ceiling is above the equilibrium price so that anything price BELOW the ceiling is feasible.  Another way to think about this is to start at a price of 0, and go up until you the price ceiling price or the equilibrium price.  If you hit the price ceiling first, it is binding.  However, if you hit the price equilibrium first, it is not.

Since our original price ceiling of $3,000 was ineffective, what happens if we drop the price ceiling to $1,000?  This will lower the price ceiling line on the graph to somewhere below the equilibrium price level.  You can now see that the equilibrium price is ABOVE the price ceiling, so it is not possible for the equilibrium price to be attained.  This means that suppliers are willing to supply a lower quantity than originally supplied (because of the lower price) and consumers are willing to demand a higher quantity than originally demanded.  This results in a shortage because quantity demanded is higher than quantity supplied.  As long as the price ceiling remains, there will be a shortage in the market, and some of those consumers that are willing and able to pay for the good will not be able to get it.


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