Price Ceiling Essay Example

Generally a price ceiling is used to protect consumers from company’s exploiting and charging extremely high prices in order to earn supernormal profits. This usually occurs in a monopoly or oligopoly price structure. Another reason a government may implement a price ceilijng is to encourage the consumption of merit goods. A price ceiling is when the government put a cap of the price of a good/ service ie a max price.

This ceiling needs to be below market equilibrium in order to be effete and will usually result in excess demand since many producers won’t be willing to provide the good t that price but consumers will increase their demand of it due to the lower price. 

A price ceiling implemented below market equilibrium will result in an increase of consumer surplus since the difference between the amount they are willing and able to pay and the actual price they pay has increased. However, the opposite is true for producers meaning that producer surplus has decreased. This is because the difference between the amount they are willing to provide the good and the actual price of the good has decreased.

However, this is all very dependant on the price elasticity of the product (PED). The more elastic it is, the more effective the price ceiling will be. Elasticity refers to the change in demand given a change in price. If a products demand is inelastic, even a huge change in price won’t effect demand by much. This means that governments should look into the elasticity of the good before implementing any price ceilings or floors because if demand is price inelastic, the policy will be largely ineffective. An example of this could be cigarettes. 

A price ceiling will usually lead to excess demand in the market. Excess demand is generally eliminated through market forces eg the shops notice that they have empty shelves and so they increase their prices. However, a price ceiling means that producers can’t increase their price. This is an example of market failure since resources aren’t being allocated efficiently and this may lead to the formation of a black market where consumers are charged even more than the original equilibrium price. This will cause both consumer and producer surplus to decrease. 

In conclusion, a price ceiling can be very effective at protecting customers and encouraging the consumption of merit goods, but only if the government implement it correctly ie figuring out whether a price ceiling would be effective in an industry due to the elasticity of the good and implementing legislation to ensure a black market doesn’t emerge due to the excess demand.