Government price fixing: ceilings and floors
A price ceiling below equilibrium causes shortages; a price floor above equilibrium causes surpluses. Both need extra government action to work.
Two kinds of price control
Worked example: shortage under a ceiling, surplus under a floor
Use the coconut market: Qd = 6,000 − 20P and Qs = 30P − 1,500 (equilibrium Rs. 150, 3,000 nuts a day). (a) The government fixes a maximum price of Rs. 120. (b) Instead, it fixes a minimum price of Rs. 180 and promises to buy any surplus.
- (a) At Rs. 120: Qd = 6,000 − 20 × 120 = 3,600; Qs = 30 × 120 − 1,500 = 2,100.
- Shortage = 3,600 − 2,100 = 1,500 nuts a day. Only 2,100 are actually sold, fewer than the 3,000 at equilibrium.
- (b) At Rs. 180: Qd = 6,000 − 20 × 180 = 2,400; Qs = 30 × 180 − 1,500 = 3,900.
- Surplus = 3,900 − 2,400 = 1,500 nuts a day.
- Cost to the government of buying the surplus = 1,500 × Rs. 180 = Rs. 270,000 a day, plus storage and waste.
(a) Ceiling: shortage of 1,500 a day. (b) Floor: surplus of 1,500 a day, costing the government Rs. 270,000 a day to buy.
Why a ceiling leads to black markets
Consequences of price fixing
| Price ceiling | Price floor |
|---|---|
| Shortages: buyers who want the good at the low price cannot get it | Surpluses: sellers cannot sell all they produce |
| Queues, waiting lists and 'first come, first served' rationing | The government must buy, store or destroy the surplus, at a cost to taxpayers |
| Black markets where goods sell above the legal price | Producers may sell below the floor illegally |
| Sellers cut quality or hide stocks | Resources are kept in an inefficient industry |
| Less investment in the industry, so future supply falls further | A minimum wage above equilibrium may reduce jobs for low-skilled workers |
Why governments still fix prices, and the alternatives
Governments fix prices to protect poor consumers from sudden price rises of essentials and to give farmers and workers a fair income. The cost is shortages or surpluses. Many economists prefer targeted cash support to poor households, subsidies that lower costs and raise supply, or building buffer stocks that are released when prices rise. These help the people in need without destroying the signal that prices send.
When a maximum retail price is fixed below the market price for a staple such as rice or eggs, traders may hold back stock and shortages appear in shops, while some sell above the gazetted price. Retailers like Cargills and Keells must plan stock and pricing around such controls.
Short answer: “What is a price ceiling?” A legal maximum price, set below the equilibrium price to protect consumers; it creates a shortage.
Structured question: “Qd = 6,000 − 20P and Qs = 30P − 1,500. Calculate the effect of a maximum price of Rs. 120.” Qd = 3,600, Qs = 2,100, so there is a shortage of 1,500 and only 2,100 units are traded.
Essay: “Explain the consequences of price fixing by the government, with diagrams.” Draw a ceiling below and a floor above equilibrium, explain shortage, queues, black markets, surplus and its cost, and suggest better alternatives.
Ceiling is low, floor is high, the opposite of a room. A ceiling below equilibrium → shortage; a floor above equilibrium → surplus.