Price Ceilings and Price Floors
In market economies, supply and demand work together to create equilibrium prices. When left alone, market prices tend to revert to the equilibrium price. This ensures that the correct amount of goods are supplied to consumers and that there won't be a surplus or shortage. Governments, however, sometimes manipulate the economy to satisfy producers or consumers who are complaining about the price of a particular good or service. There are two methods governments typically employ to fix prices at a certain level: price ceilings and price floors.
Price Ceilings
A price ceiling sets the highest price that can be charged for a good or service. Generally, price ceilings are instituted to reduce the price of a particular product, in order to satisfy consumers that are complaining about the cost. Because of this, price ceilings are usually set below the equilibrium price.
Rent control is a common example of a price ceiling. In many cities, rent controls have been established to combat rising housing costs. Poorer city residents were having difficulty keeping up with increased rental costs, so local governments created price ceilings for rent prices.
This sounds great for poorer citizens who can't afford high rental costs. But do you remember what happens when the market price is set below the equilibrium price? A shortage develops. Thus, whenever a price ceiling is instituted that's below the equilibrium price, it will cause a shortage. So if the equilibrium price for apartment rent is $1,500, but there is a price ceiling of $1,000, it will result in a shortage of apartments. Instead of renting out their buildings, property owners might convert them to condominiums and sell them. Or, if the price ceiling is incredibly low, they might decide it's better just to leave the building empty and not rent it out at all. And a low price ceiling certainly won't attract new entrepreneurs to build more apartments.
Therefore, the main result of rent control is that it benefits some people at the expense of others. Those who manage to find a vacancy in a rent-controlled apartment will be helped by the program. Most newcomers to the city, however, will be unable to find an affordable place to live. They'll have to travel outside the rent-controlled area to find an apartment, which will usually be much more expensive. Rent control also doesn't usually benefit the people it's intended to help: the poor. Instead, it benefits current apartment owners (regardless of their incomes). Even if they could afford to live elsewhere, those who live in rent-controlled apartments will be hesitant to give them up because they know it'll be extremely difficult to find another rent-controlled vacancy in the future.
Price Floors
The opposite of a price ceiling is a price floor, which fixes the lowest price at which one can buy a good or service. Whereas price ceilings typically help consumers, price floors help producers. So price floors are usually set above the equilibrium price, which results in a surplus.
Price floors are commonly established in agriculture. Throughout American history, farmers have periodically struggled to make enough money selling their crops. In an effort to help farmers, the American government has created price floors on many agricultural products. For instance, they might say that no one can sell corn in America for less than five dollars a bushel. But since that's more than most consumers are willing to pay, it would result in a surplus of corn. Consumers end up paying more money for less food, and they have less cash to spend in other areas of the economy.
Stabilizing Commodities
Before finishing the lesson, you'll read another chapter of Economics in One Lesson. In Chapter 16, Hazlitt writes about the American government attempting to stabilize the price of commodities, usually crops. In the chapter, he discusses two different strategies the government has historically used. One is setting price floors for agricultural products. As we've seen, however, this results in a surplus of those products. Farmers will end up with rotting, unsold crops that no one wants to buy because the price is too high. So another strategy the government employed was to pay farmers to not grow crops. That's right—the government gave money to farmers in exchange for not producing something on their land. The idea was to reduce supply, which (as we've learned) raises the equilibrium price. This restriction of output creates a whole other set of problems, which you'll learn about in your reading.
Review of Key Terms
price ceiling: the highest price, set by the government, that can be charged for a good or service
price floor: the lowest price, set by the government, at which one can buy a good or service
Governments often have good intentions when establishing price ceilings and price floors. But while they may solve one issue, they tend to create many others in the process. In the next lesson, you'll read more about Hazlitt's take on government price-fixing.