Price Ceiling

Price ceiling: no more than a dollar a square foot in rent. And yes, it’s called rent control.

Price floor: you can’t sell arsenic for less than $100/gallon, because, well, probably too many people would die if they drank it.

So yeah…when the government sets a maximum price for something, that’s called a price ceiling. The rent control measures in New York City establish a price ceiling for the rental rates of certain buildings, built in certain times, with certain tenants. The process is rife with corruption (many wealthy people live in these rent-controlled buildings), but for our purposes, just know that they set a max rental rate, and that’s a price ceiling.

The intention behind setting a price ceiling is arguably a good one: a certain good or service has become so expensive that it’s nearly impossible for many people to afford, so we want to make it more affordable. How many times have we said to ourselves, "I wish this thing that I need was cheaper?" Price ceilings are the government’s way of trying to make that wish come true. But, like all things literary, there’s a price to pay for trying to defy gravity.

Of course, setting a price cap can deliver unintended consequences. If a price ceiling is set below the equilibrium price for that good or service, a shortage results. What’s an equilibrium point? In economic terms, it’s where supply and demand meet. It shows how supply changes as prices change: that’s the supply curve. If there’s a lot of demand for a given product at a given price, if it makes sense to produce more, than producers will…produce more. Duh. Then there's the demand curve, which shows how demand changes as prices change. Where the two curves intersect is the equilibrium point. It’s where the market reaches a balance between supply and demand. That is, it’s where the prices are such that sellers and buyers are both equally happy and unhappy. Kind of like Mom at Thanksgiving.

But what happens if the government mandates the setting of an artificial price? That is, they don’t let the market reach its equilibrium point? Yeah...you get problems. In the case of rent control, you’ve got a price below the equilibrium point. You end up with too much demand for too little supply. Like...who wouldn’t want to pay $400 a month for a beautiful 4-bedroom apartment overlooking Central Park?

Another example. Immediately after a snowstorm, people run to the store to get road salt (if you live in California or anywhere else where changes in weather don’t exist, people put salt on roads so the ice on the roads melts off because, uh… science). In order to make driving and walking conditions safe, the government caps the price of rock salt so that everyone can afford it. And this makes sense, because it would be bad for a whole lot of innocent street-walkers, er, rather, people walking on the street, to have a bunch of road unsalted and icy, and drivers then running into them. In essence, in forcing rock salt prices to be low, the government is protecting a bunch of innocent potential victims. But there is a price to pay in this protection. The low prices mean people bum rush stores and clear ‘em out. The shortage of rock salt comes about because stores can’t meet consumers’ demand.

Let’s say we live in a city where the equilibrium price for a one-bedroom apartment is $1,200, and the government institutes a price ceiling of $1,000. The price cap messes with the market, impacting both supply and demand. Demand is increased, because now there are people who can afford the apartment who couldn’t come up with the cash when it was $200 more expensive. That’s the government’s goal: to let people afford these apartments who otherwise...couldn’t.

But the policy also affects supply. A government price control obviously doesn’t instantly destroy a bunch of apartments. But it changes the incentive structure to make it less profitable to rent out these apartments. Owners will start looking for places to put their resources. They may turn the apartments into condos. They might sell the buildings altogether or try to turn it into retail space. Over the long run, fewer new apartments of this type will be built, because investors aren’t there for the current price structure.

The opposite of a price ceiling is a price floor, which is a government-imposed limit on how low the price of a good or service can go.

Example:

After the Great Depression, the U.S. government instituted several price floors in agricultural markets in an effort to protect farmers from the horrible economy. This was all part of the New Deal...that thing Franky D. came up with to give victims of the Depression. A bit of financial relief.

Let’s bring things forward in time a bit. Pretend the government decided to set a price floor of $5 for the newest iPhone. That means no one could charge less than $5 for the new iPhone. Since new iPhones clearly cost the manufacturer (Apple) more than $5—like, a bunch more—we can say with some confidence that the equilibrium price for an iPhone is higher than the price floor. In this situation, the price floor has pretty much no effect on anything.

Right? Because Apple has no incentive to make any more iPhones if they cost them, say, $200, and the government is telling them they must sell them for more than $5 each. Well, of course they will. iDuh.

But let’s say that price floor was changed from $5 to $500, and now no one can sell an iPhone for under five hundred bucks. That changes things a little, doesn’t it? First of all, most of us are probably not going to run right out and buy a new iPhone. Second, anyone who does pay $500 for their phone is now paying a price that is higher than the equilibrium price. Third, given the dramatic drop in demand, Apple’s going to end up with a major surplus of iPhones, if they don’t do anything about supply. Like…they’d better cut back on supplies, because now this ultra-expensive iPhone is going to have less volume demand than it would if it sold for, say, $300.

Assume the equilibrium price for an iPhone is $250. Apple is selling iPhones at an artificially high price; that is, a price above the equilibrium point. There’s a big gap between where the price floor hits the supply curve and where it hits the demand curve. At $500, Apple wants to make a lot of iPhones. But unfortunately for them, not many people want to buy at this price.

There are benefits and drawbacks to price controls. They can protect consumers by making sure they can afford what they need, and they can protect companies by making sure they won’t go broke producing their goods and services that they might not otherwise make. But they can also lead to economic disequilibrium, where supply and demand are artificially controlled and lead to shortages and surpluses.

Like finding an affordable apartment in the Windy City, instituting price controls involves making some trade-offs.