Price ceilings cause economic shortages.
A price ceiling is a form of price control where the government mandates the maximum price for a certain item. This is not the norm in a free-market economy in which the law of supply and demand establishes a market price. The government usually sets price ceilings in response to very high prices that cause social or political unrest.
Free Market Equilibrium
A free-market economy is supposed to be free of outside controls, especially from the government. The price of any given item in a free market is based on the relative supply and demand of that item. Supply and demand will be in equilibrium when the item is at a fair market price. As demand increases or decreases, so will the price. Price will change inversely to changes in supply. However, a price ceiling control imposed by the government changes the price without the normal requisite change in supply or demand.
Increased Demand
An imposed price ceiling on an item, with all else being equal, will cause the demand for that item to increase. If the free market price for potatoes is one dollar per pound and then the government places a maximum price of 80 cents per pound, consumers will want to buy more of them. This is true for items such as gasoline or electricity as well. This would usually be no problem in a free-market situation, because the market would respond with an increase in supply. However, this does not occur when there is a price .
Decreased Supply
In a free market, the incentive for sellers to produce items is the price they can charge for that product. With increased demand, prices tend to go up, creating an incentive for sellers to increase supply. This will eventually cause an equilibrium of supply and demand. However, with a price ceiling, prices are not allowed to increase. Therefore, even though there is an increase in demand, sellers will not increase supply because the price is restricted. This leads to too much demand and not enough supply, or what is called an economic shortage.
Consequences and Options
The shortage created by the price ceiling has consequences best demonstrated by a classic example -- rent control. Rent controls increase demand while decreasing the supply of rental apartments. This causes a housing shortage and resulting payments of bribes and extortion and even a black market for apartments. The government wanted affordable housing by instituting rent control, but created a housing shortage. If the government provides incentives to increase the supply of rentals, such as lower taxes and mortgage interest, then the resultant increased supply will lower rent prices and not create a housing shortage.
Tags: price ceiling, increase supply, housing shortage, market price, , ceiling control