How price ceilings and price floors affect market outcomes

Equilibrium without controls. In a free market the price settles where quantity demanded equals quantity supplied; at a higher price there is excess supply and the price falls, at a lower price there is excess demand and the price rises. Governments sometimes regulate the price when the market price is thought too high or too low. A control matters only if it binds: a ceiling set above the equilibrium price, or a floor set below it, changes nothing, because the market price already obeys it.

Price ceiling.

• Meaning. A price ceiling is a legal maximum price, an upper limit set by the government. It is usually put on necessities such as wheat, rice, kerosene and sugar, and is set below the market price so that poorer households can afford them.
• Outcome 1: shortage. At the low price, buyers want more than sellers are willing to supply, so there is excess demand: the quantity actually traded falls to what sellers offer.
• Outcome 2: rationing. The limited supply has to be shared out some other way than by price, for example by ration coupons and sale through fair price shops, which fix how much each household may buy.
• Outcome 3: queues and black markets. Consumers wait in long queues at ration shops, and because many are not satisfied with their ration, some are willing to pay more than the legal price, which breeds a black market.
• Example (our own): a ceiling on the price of cooking gas cylinders below the market price would leave many households waiting for refills and some paying extra to dealers.

Price floor.

• Meaning. A price floor is a legal minimum price, a lower limit set by the government, set above the market price because a fall below it is thought undesirable.
• Outcome 1: surplus. At the high price, sellers offer more than buyers want, so there is excess supply.
• Outcome 2: the government must deal with the surplus. Under an agricultural price support programme, the government has to buy the surplus at the support price to stop the price falling; for example, procurement of wheat at a minimum price keeps farmers producing it.
• Outcome 3: the labour market. A minimum wage set above the equilibrium wage is a floor on the price of labour: more people want work at that wage than employers wish to hire.

Conclusion. A binding ceiling helps buyers who get the good at the low price but creates a shortage, rationing, queues and black markets; a binding floor helps sellers who sell at the high price but creates a surplus that someone (often the government) must absorb. In both cases price no longer clears the market.