Price floors and price ceilings
A price floor is a government-mandated minimum price for a good or service. An example of a price floor is the minimum wage. Producers may not pay below the legal minimum in wages for labor.
A price ceiling is a government-mandated minimum price for a good or service. An example of a price ceiling is rent control. A landlord may not charge over the legal maximum in rent. The government uses price ceilings and price floors because on some instances when supply and demand intersect it is not beneficial to society as a whole. When this occurs, the government intervenes and sets a price floor or ceiling to purposefully create a surplus or shortage. For a price floor to be effective, the government must set the legal minimum above the equilibrium price. For a price ceiling to be effective, the government must set the legal maximum below the equilibrium price. Both of these points are illustrated in figure 2-7.
Notice that the price floor automatically creates a surplus because price floors are typically higher than the equilibrium price. If a higher price is established, then according to our law of demand, fewer people will consume and a surplus will result. Price floors can be a useful tool for rationing by the government. If demand becomes too great in any instance, a price floor would eliminate any shortage by promoting a higher price.
A price ceiling, on the other hand, creates a shortage. With a shortage, the government can promote or encourage demand for a specific good or service. Primarily, the government introduces a price ceiling in an attempt to level the playing field for consumers. If the government applies a price ceiling, it typically means that the forces of supply and demand are becoming a social cost rather than a social benefit.
Ineffective price floors and ceilings are usually placed below the equilibrium price. When this is done, the supply or demand isn ’ t changed because the market clearing price takes precedence over any artificial price. For a price floor or ceiling to be truly effective, floors must be placed above the equilibrium price and ceilings must be placed below the equilibrium price.