When the economy is in a state of flux, the government may set minimums and maximums on the price of some goods and services. These price floors and price ceilings are used to help manage scarce resources and protect buyers and sellers. However, a price ceiling and price floor can also result in some inefficiencies in the marketplace.
Price floors and price ceilings are similar in that both are forms of government pricing control. These price controls are legal restrictions on how high or how low a market price can go.
The price floor definition in economics is the minimum price allowed for a particular good or service. The price ceiling definition is the maximum price allowed for a particular good or service. In general, price ceilings contradict the free enterprise, capitalist economic culture of the United States.
The price floor is intended to protect the overall value of a given industry and its producers by setting a minimum threshold. A price floor prevents companies from undercutting standard market prices. Examples of price floors include:
- Minimum wage
- Agricultural subsidies
While low-cost providers exist in many industries, the government is most concerned with setting floors in industries where illegal operators or black-market providers can steal business through unethical means.
The price ceiling is intended to protect the consumer marketplace by limiting the top price industry providers can set. Price ceilings are often set during times of crises such as natural disasters, times of war or harvest failures so dramatic price increases in scarce goods are prevented.
This price control is also common when significant barriers to entry prevent competition or when the government believes it is better for society to minimize providers. Examples of price ceilings include:
- Rent control
- Food price control
- Oil industry
Local utilities often have price ceilings because they are heavily regulated by local governments.
While setting a price ceiling and price floor has its benefits, there can be drawbacks to determining the highest and lowest price of a good or service.
For example, a price floor is problematic when market supply does not dictate enough demand for existing suppliers at that price. A price floor can lead to inefficient allocation of sales among sellers and selling high-quality goods at a high price when a lower-quality item at a lower price would do.
Another unintended consequence of a price floor comes into play in professions that are regulated and require licensing, such as electricians. Requiring electricians to be licensed keeps many from entering the profession, allowing those who are licensed to set higher fees since supply is low and demand is high. The unintended consequence of this is that people attempt to save money by fixing their own electrical problems themselves, often to disastrous and much more costly results.
In a typical competitive marketplace, a price ceiling may cause shortages when the perceived market value exceeds the ceiling. A price ceiling can also result in wasted resources, inefficient allocation to customers and black markets where people can buy unregulated versions of the good for much less.
The government takes a lot into consideration when setting a price ceiling or a price floor and often determines that the benefits outweigh the risks for that particular good or service.