Showing how price ceilings and price floors change market outcomes

The market without controls. Left to itself, a competitive market settles at the price where the quantity demanded equals the quantity supplied; above it there is excess supply and the price falls, below it there is excess demand and the price rises. Our own schedule for arhar dal in a city market (₹ a kg, tonnes a week) shows this:

Without any control, the market clears at ₹160 with 600 tonnes bought and sold. A government sometimes steps in when it thinks the market price of a good is too high or too low.

Price ceiling.

• Meaning. A price ceiling is a maximum price fixed by the government. It is usually placed on necessities, such as wheat, rice, kerosene and sugar, and fixed below the market price so that poorer buyers can afford them.
• Shortage. Suppose a ceiling of ₹120 is fixed. Buyers now want 800 tonnes but sellers offer only 400: a ceiling below the equilibrium price creates excess demand, here a shortage of 400 tonnes.
• Less is traded. Sellers cannot be made to sell more than they offer, so only 400 tonnes change hands, against 600 before. Buyers who get dal pay less, but many go without.
• Rationing and queues. Since price can no longer share out the scarce quantity, the government may ration it, issuing coupons that cap each household's purchase at fair price shops; buyers then have to wait in long queues.
• Possible black market. Buyers left unsatisfied by their ration may be willing to pay more than the legal price, and this may give rise to a black market.

Price floor.

• Meaning. A price floor is a minimum price fixed by the government for goods whose price it does not want to fall below a certain level; it is set above the market price. Support prices for farm crops and minimum wages are the best-known cases.
• Surplus. Suppose instead a floor of ₹180 is fixed. Sellers now offer 700 tonnes but buyers want only 500: a floor above the equilibrium price creates excess supply, here a surplus of 200 tonnes.
• The government must take up the surplus. Under a farm support programme, the government has to buy the unsold 200 tonnes at the floor price to keep the price from falling. Farmers gain a price that lets them keep producing, while private buyers pay more and buy less (500 tonnes instead of 600).
• The labour market. A minimum wage is a floor on the price of labour, set above the equilibrium wage; at that wage more people offer to work than employers want to hire.

When a control has no effect. A control changes the outcome only when it binds. In the schedule, a ceiling of ₹180 or a floor of ₹120 would leave the market at ₹160 and 600 tonnes, because the market price already satisfies it. It is a ceiling below, or a floor above, the equilibrium price that creates excess demand or excess supply.

Conclusion. A binding ceiling lowers the price but cuts the quantity traded and creates a shortage, which brings rationing, queues and possibly a black market. A binding floor raises the price but creates a surplus that someone, often the government, has to absorb. In both cases price no longer brings quantity demanded and quantity supplied into line.