A price ceiling is a government-imposed price control, or limit, on how high a price is charged for a product. Governments use price ceilings to protect consumers from conditions that could make commodities prohibitively expensive. Such conditions can occur during periods of high inflation, in the event of an investment bubble, or in the event of monopoly ownership of a product, all of which can cause problems if imposed for a long period without controlled rationing, leading to shortages. Further problems can occur if a government sets unrealistic price ceilings, causing business failures, stock crashes, or even economic crises. In unregulated market economies, price ceilings do not exist.
Video Price ceiling
Real-world examples
Rent control in New York City
Rent control is a price ceiling on rent. When soldiers returned from World War II and started families (which increased demand for apartments), but stopped receiving military pay, many could not deal with higher rents. The government put in price controls, so soldiers and their families could pay their rents and keep their homes. However, it increased the quantity demand for apartments and lowered the quantity supplied, meaning that available apartments rapidly decreased until none were available for late-comers. Price ceilings create shortages when producers are allowed to abdicate market share or go unsubsidized.
Apartment price control in Finland
According to professors Niko Määttänen and Ari Hyytinen, price ceilings on Helsinki City Hitas apartments are economically highly inefficient. They cause queuing, and discriminate against the handicapped, single parents, elderly, and others not able to queue for days. They cause inefficient allocation, as apartments are not bought by those willing to pay the most for them--and those who get an apartment are unwilling to leave it, even when their family or work situation changes since they can't sell it at what they feel the market price should be. These inefficiencies increase apartment shortage and raise the market price of other apartments.
The "Coulter law" in Australian rules football
Uniform wage ceilings were introduced in Australian rules football to address uneven competition. In the Victorian Football League (VFL) a declining competitive balance followed a 1925 expansion that had admitted Footscray, Hawthorn and North Melbourne. The effects on financially-weaker clubs were exacerbated in 1929 by the beginning of the Great Depression. From 1930, a ceiling system, formulated by VFL administrator George Coulter, stipulated that individual players were to be paid no more than A£3 (approximately A$243 in 2017) for a regular home-and-away match, that they must also be paid if they were injured, that they could be paid no more than A£12 (approx. A$975 in 2017) for a finals match, and that these wages could not be augmented with other bonuses or lump-sum payments. The "Coulter law", as it became known, remained a strictly binding price ceiling through its history.
During its early years, the Coulter law adversely affected only a minority of players - such as stars and players at wealthier clubs. These individuals experienced, in effect, a drastic cut in wages. For instance, from 1931 the ceiling payment of £3 per game fell below the legal minimum award wage. While, players at the more successful clubs of the day, such as Richmond had previously paid significantly higher average wages, clubs that were struggling financially often could not meet the ceiling under the Coulter law. Clubs with a long-standing amateur ethos became significantly more competitive under the Coulter law - such as Melbourne, which had long attracted and retained players by indirect or non-financial incentives (e.g. finding players employment not related to football). The Coulter law led to at least one VFL star of the 1930s, Ron Todd moving to the rival VFA, because he was dissatisfied with the maximum pay he could receive at Collingwood,
As a result of World War II, the wage for a regular game was halved (to £1/10 shillings) for the 1942-45 seasons. After the war, the ceilings were modified several times in line with inflation. During the 1950s, "Coulter law" was also blamed for shortening the careers of star players such as John Coleman and Brian Gleeson, because it prevented them and their clubs from paying for the private surgery that the players required to continue their careers.
The Coulter law was abolished in 1968. However, in 1987 a club-level salary cap was introduced by the VFL and has been retained by its successor, the Australian Football League (AFL).
State Farm Insurance
On February 4, 2009, a Wall Street Journal article stated, "Last month State Farm pulled the plug on its 1.2 million homeowner policies in Florida, citing the state's punishing price controls... State Farm's local subsidiary recently requested an increase of 47%, but state regulators refused. State Farm says that since 2000 it has paid $1.21 in claims and expenses for every $1 of premium income received."
Venezuela
On January 10, 2006, a BBC article reported that since 2003, Venezuela President Hugo Chávez had been setting price ceilings on food, and that these price ceilings had caused shortages and hoarding. A January 22, 2008, article from Associated Press stated, "Venezuelan troops are cracking down on the smuggling of food... the National Guard has seized about 750 tons of food... Hugo Chavez ordered the military to keep people from smuggling scarce items like milk... He's also threatened to seize farms and milk plants..." On February 28, 2009, Chávez ordered the military to temporarily seize control of all the rice processing plants in the country and force them to produce at full capacity, which he alleged they had been avoiding in response to the price caps.
On January 3, 2007, an International Herald Tribune article reported that Chávez's price ceilings were causing shortages of materials used in the construction industry. According to an April 4, 2008, article from CBS News, Chávez ordered the nationalization of the cement industry in response to the industry exporting its products to receive higher prices outside the country.
Maps Price ceiling
Price ceilings that lead to higher prices
There is a substantial body of research showing that under some circumstances price ceilings can, paradoxically, lead to higher prices. The leading explanation is that price ceilings serve to coordinate collusion among suppliers who would otherwise compete on price.
More precisely: Forming a cartel is profitable, because it enables nominally competing firms to act like a monopoly, limiting quantities and raising prices. But forming a cartel is difficult, because it is necessary to agree on quantities and prices, and because each firm will have an incentive to "cheat", that is, to sell more than agreed at by lowering prices. (Antitrust laws make collusion even more difficult because of legal sanctions.) Having a third party such as a regulator announce and enforce a maximum price level can make it easier for the firms to agree on a price and to monitor pricing. We can view the regulatory price as a focal point which is natural for both parties to charge.
One research paper documenting this phenomenon is Knittel and Stangel, which found that in the 1980s in the United States, in states that fixed an interest rate ceiling of 18 percent, firms charged a rate only slightly below the ceiling. But in states without an interest rate ceiling, interest rates were significantly lower. (The authors did not find any difference in costs which could explain the result.) Another example is Sen et al. who found that gasoline prices were higher in states that instituted price ceilings. Another example is the Supreme Court of Pakistan decision regarding fixing a ceiling price for sugar at PKR45/kg. The result was sugar disappeared from the market due to a cartel of sugar producers and the failure of the Pakistani government to maintain supply even in the stores owned by the Government against the large demand of the sugar. The imported sugar required time to reach the country, and it was not feasible to sell at the rate fixed by the Supreme Court of Pakistan. Eventually, the government went for a review petition in the Supreme Court and sought the withdrawal of the earlier decision of the apex court. Eventually, fixation of ceiling price was withdrawn and the market equilibrium was achieved between PKR55-60/kg (Supreme Court of Pakistan decision, 2006-2007).
See also
References
Further reading
- Rockoff, Hugh (2008). "Price Controls". In David R. Henderson (ed.). Concise Encyclopedia of Economics (2nd ed.). Indianapolis: Library of Economics and Liberty. ISBN 978-0865976658. OCLC 237794267. CS1 maint: Extra text: editors list (link)
Source of the article : Wikipedia
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