Price Ceilings: Shortages and Reductions in Quality

Price Ceilings

  • Priceceiling:Price ceiling: a maximum price allowed by law
  • Create 5 important effects:

  

  1. Shortages
  2. Reductions in product quality
  3. Wasteful lines and other search costs
  4. A loss of gains from trade
  5. A misallocation of resources

Shortages

  • When prices are held below the market price, the quantity demanded exceeds the quantity supplied
  • Shortage is measured by the difference between the quantity demanded at the controlled price and the quantity supplied at the controlled price
    • The lower the controlled price is relative to the market equilibrium price, the larger the shortage
    • Ex: the increased demand for steel bars would increase the price of steel bars, encouraging more production
    • But with a price ceiling in place, demanders could not signal their need to suppliers and they couldn’t provide suppliers with an incentive to produce more

Reductions in Quality

  • At controlled price, demanders find that there is a shortage of goods (they can’t buy as much of the good as they would like)
  • At the controlled price, sellers find that there is an excess of demand (sellers have more customers than they have goods)
    • Usually, this would be an opportunity to raise prices, but when prices are controlled, sellers can’t raise prices without violating the law
    • It’s much easier to evade the law by cutting quality than by raising prices, so when prices are held below market levels, quality declines
    • Ex: cars being painted with fewer coats of paint
  • Another way quality can fall is with reductions in services
    • Usually, sellers have an incentive to please their customers, but when prices are held below market levels, sellers have more customers than they need or want
    • Customers without potential for profit are just a pain, so when prices can’t rise, service qualities will probably fall
    • Ex: the full-service gasoline station disappeared with price controls, and instead of staying open for 24 hours, gasoline stations would close whenever the owner wanted a lunch break