In the business world, governments sometimes intervenes to make sure that supply and demand remain at optimal levels. To do this, the government may impose pricing rules on certain commodities or items. These price ceilings and price floors can be beneficial in certain situations, but they can also lead to surpluses or shortages.
Price Floor
When a government sets a price floor, it is essentially setting the minimum sales price for the item. When a price floor is used, suppliers cannot sell goods below the price mandated by the government. If they do, they could face penalties and fines from the government. For example, the government could decide to set a price floor on corn of $100 per bushel. If this happened, farmers could not sell it to the public below this amount.
Price Ceiling
A price ceiling is similar to a price floor except that it puts a maximum amounts on what a product can be sold for. With this approach, the government does not care how cheaply you sell the goods, but you cannot exceed the maximum price of the price ceiling. This is designed to make products more affordable for the general public, but it can also hurt the distributors and sellers of the products in question.
Effect of Price Floor
A price floor can have several different effects. If the price floor is set at a level that is below the current market price, it should not have any effect. However, if the price floor is set at a price that is above the market price, it could create a surplus. Buyers will be less willing to pay for the products when they are at that level. In some cases, governments will guarantee a minimum payment to the supplier by paying subsidies.
Effect of Price Ceiling
A price ceiling can also have varying effects on the market in general. While a price floor can cause a surplus, price ceilings can cause shortages. Manufacturers or producers will be less likely to create any more of the product than they have to. If they cannot produce it profitably, they may get out of the business completely. This helps protect consumers from having to pay too much for goods.
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