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MAXIMUM PRICE (PRICE CEILING) – A TYPE OF PRICE CONTROL

Updated on March 11, 2011

Maximum price or price ceiling is a price established by governments beyond which it is illegal to sell. Price controls are government rules or laws that forbid the adjustment of prices to clear the market. Price ceiling is one of two types of price control. The purpose of price ceilings is to protect the interest of consumers, particularly when it is felt that the equilibrium price is unreasonably too high. In times of war or when shortages occur, due to a fall in economic activity, price control may be used to prevent inflation and also to enable people in the low income bracket to be in position to demand more goods and services

If the ceiling price is set above the equilibrium price, it has no effect of protecting the interest of the consumer. The equilibrium price is the price at which demand and supply are equal so that there is no excess demand or excess supply. The consumer’s interest is not served by setting the ceiling price above the equilibrium price because the equilibrium price which was considered too high, for which reason the ceiling price was imposed, would now have the ceiling price above it. If however, the ceiling price is set below the equilibrium price it determines the price, and in this case it is said to be binding. For all practical purposes of protecting consumers’ interest, therefore, maximum prices are always fixed below the equilibrium price.

When maximum prices are fixed below the equilibrium price, quantity demanded increases because price has been reduced from a higher equilibrium price. At the same time suppliers reduce the quantity they offer for sale. With quantity demanded increasing and quantity supplied decreasing; we experience shortages or excess demand oversupply. The shortage so created from the maximum price legislation would lead to a number of sales devices, which include the following:-

1. If shops sell to the first customers who arrive, people are likely to rush to those stores that are rumored to have any stock of the scarce commodity. Long queues may develop and allocation will be on the basis of luck.

2. The principle of first come – first served could be employed.

3. Sometimes shop keepers themselves decide who will get the scarce commodity and who will not. They may keep commodities under the counter and sell only to regular customers, or to people of a certain color or religion. Such a system is called allocation by sellers’ preferences.

4. If the central authorities dislike the allocation system that results from price ceiling, they can ration the goods by giving out ration coupons sufficient to purchase the available supply. The authorities then determine as a conscious act of policy, how the available supply is to be allocated. The coupons might be distributed equally, or on such criteria as age, sex, marital status or number of dependents. Note that rationing substitutes government’s preferences for the seller’s preferences, in dividing up a commodity that is in shortage, because of a binding price ceiling.

5. Under certain circumstances, maximum price control, with or without rationing, is likely to give rise to black markets. This is a market in which goods are sold illegally at prices that violate the legal restrictions.

The shortage that results from the maximum price legislation exerts pressure on the ceiling price upwards. This is because people will be prepared to pay higher prices just to have the scarce commodity. With the above effects of a ceiling price, the pressure on the equilibrium price can raise price above the initial equilibrium price which was considered too high, for which reason the maximum price was imposed. Maximum price legislation are therefore likely to fail due to the shortage they may create.

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