A Guide to Price Ceiling and Price Floor

  • Pragya Soni
  • Oct 21, 2021
  • Financial Analytics
A Guide to Price Ceiling and Price Floor title banner

Have you ever wondered how variable the market economy is? How can the price of the same commodity change so many times in a fiscal year? Obviously, climate and weather are important factors. But what are the other factors that govern the rate change of this process? 

 

The answer is price ceiling and price floor. What do these terms mean and how do they control the market? In this blog we will learn about these two terms and the difference between them. 

 

(Read blog - Expansionary Fiscal Policy?)


 

What is the Price Ceiling?

 

The Price Ceiling is a government mandated price. It is an important controlling term of the market economy. First, let us understand its meaning in general terms. The term comprises two words Price and Ceiling. 

 

Price of a commodity is an exchange money value of that commodity. Like what is the worth of the product in terms of money, ceiling in the layman’s language is the inner top roof of a house. Or in simple words, the ceiling is the top surface of the house. 

 

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Similarly, price ceiling is the top price or maximum rate of a commodity. Usually, the price ceiling is fixed by the government’s laws and rules. It is the maximum amount that a seller can charge for its product or service.


 

What are the features of the Price Ceiling?

 

Price Ceiling has the following features. 

 

  1. Price ceiling is mandated by the government of the country.

 

  1. No seller can sell his goods at a price higher than the price ceiling.

 

  1. Price ceiling is applicable to the staple goods, such as food, medicines, gas, etc.

 

  1. It is the opposite of the price floor.

 

 

How does the price ceiling control the market economy?

 

Price ceiling is the controller of the market economy. It has its direct or indirect link with the demand rate of a commodity. As mentioned earlier, the price ceiling is the maximum rate of a product. Now, when such rates are governed by the government. 

 

Sellers or the producers can’t make the high profits. This process, thus, maintains the market equilibrium. Now, in the greed of high profits, some sellers might use black way. For example, a seller can reduce the production of a commodity, or he can hide it from the direct market sell. 

 

(Related blog - Inflation)

 

This will ultimately reduce the supply of that commodity in the market, the demand for the same will increase. This process is the non-equilibrium state of the market. Now when the supply is not able to meet the demand rate of the product. Its ceiling price will ultimately increase. 

 

Thus, opening more profits to the sellers. Especially for the seller who has frozen his products rather than keeping them in the market. Economists define this process as deadweight loss.

 

Deadweight loss may be defined as a state when the market is not in equilibrium. Or in simple words when there is an imbalance between supply and demand of a product. Market insufficiency is the key factor responsible for deadweight loss.

 

 

What are the advantages and disadvantages of the Price Ceilings?


 

Now, let us learn about the merits and demerits of the price ceiling.

 

Advantages of price ceiling

 

Following are the advantages of the price ceiling in economy:

 

  1. Price of the product can’t rise then the price ceiling.

 

  1. Product is available at lower cost to the consumers.

 

  1. The price of the commodity turns uniform throughout the region.

 

Disadvantages of price ceiling

 

Long term, implementation of price ceiling can have following demerits:

 

  1. It can lead to deadweight loss.

 

  1. It can increase black marketing.

 

  1. Sometimes, the seller charges extra price on the account of service not mentioned by the government.


 

What is the Price Floor?

 

After learning about price ceilings, let us understand the meaning of price floor. Price floor is also a government mandated price. It is also known as minimum support price. It helps to control market regularity. 

 

Let us learn about the concept of price floor in layman’s terms. The term Price Floor consists of two words, price and floor. Price as mentioned above is the worth of a product in money. 

 

(Recommended blog - Wholesale Price Index)

 

The floor is the most basic or the grounded part of a building. Similarly, price floor is the most basic or genuine rate of a product. It is the minimum amount that a seller can ask his customers for a product or service. Like the price ceiling, the price floor is also fixed by the government.

 

 

What are the features of the price floor?
 

Price floor has the following features:

 

  1. Price floor is a government mandated price, i.e., price floor is controlled by the government of the country.

 

  1. Price floor the lower acceptable amount on a product.

 

  1. No customer can bargain more below the price floor.

 

  1. Price floor is set up by the government on essential commodities, such as grains and medicines.

 

  1. For luxury commodities and in private business, the price floor is set by the company. 


 

How does the price floor control the market economy?

 

Once the price floor of a product is fixed by the government, it affects the market economy in many ways. Now no one can bargain with a producer for a cheaper price. This helps poor producers to at least meet their cost of production. 

 

If by chance the cost of production of a product is not met in a fiscal year. The producer thinks a thousand times before producing that product or commodity again. This will further not be able to meet the demand of the product in coming years. And will disturb market equilibrium. 

 

(Recommended blog - Factors affecting Price Elasticity of demand)

 

But the price floor is a savior in such circumstances. Also, if the price floor doesn’t exist in the market. The demand rate of goods will never increase. As the customers will try to get the products at a cheaper price, this will increase the competition of producers in the market and a huge instability among them. 

 

Each producer in order to sell his product, will reduce his selling price. The market will be flooded with the product. The demand of the product will never increase. When demand doesn’t increase, the market also stops growing. 

 

This will lead to a stagnant market which may be defined as a market phase when the market neither expands or shrinks.

 

Read more about Market Stagnancy from Robinhood.


 

What are the advantages and disadvantages of the price floor?

 

Price floor is the opposite of price ceilings. The merits and demerits of the price floor are as listed below.

 

Advantages of price floor:

 

Following are the advantages of the price floor:

 

  1. The minimum fixed price for a commodity supports the basic needs of a producer. It helps them to ensure cost of living for producers.

 

  1. Price floor increases the cost of living, thus increases the federal minimum wages.

 

  1. Price floor helps in maintaining labor stability.

 

Disadvantages of price floor:

 

The ill-maintained price floor system can lead to following consequences:

 

  1. Price floor may increase the supply of goods in the market.

 

  1. Sometimes, it can lead to unintended consequences like market stagnation. 

 

 

What is the difference between price ceiling and price floor?


 


1. Price ceiling is the maximum price for a commodity, while, price floor is the minimum price for a commodity.2. Price ceiling protects the interest of customers, while price floor protects the interests of producers.3. Price ceiling can lead to dead weight loss, while price floor cause market stagnation.

Difference between the price ceiling and price floor


Price floor and price ceiling are opposite to each other. Though, both price ceiling and price floor are government mandated prices and both help in controlling the market, yet, they are different from each other because of their different meanings and different roles in the economy. Here are the major differences between price ceiling and price floor.

 

(Suggested Read - PESTLE Analysis)

 

  1. Price ceiling is the maximum price on a product while the price floor is the minimum price on a product.

 

  1. Price ceiling protects the interests of consumers, while price floor protects the interests of producers.

 

  1. Price ceiling may decrease the supply demand in the market, while price floor may increase the supply demand.

 

  1. Price ceiling can cause deadweight loss while price floor causes market stagnation.


 

Both price ceiling and price floor are important factors of the market growth and economy. They are the controlling factors of the market and are responsible for giving directions to the market economy. Though, they are different from each other. But they have one thing in common that they are market controlling factors. 

 

A little change in the economic system can make the market conditions of the globe much better. Policies and efforts should be made to remove the side effects of these two factors i.e., market stagnation and deadweight loss. Once these gaps are filled, the market economy will set a new trend.

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