Which term refers to a legally established maximum price that firms may charge group of answer choices a tariff a subsidy a price floor a price ceiling?

Do you eat your fruit and veg daily? Fruits and vegetables are widely accepted as healthy foods that improve the lives of their consumers and increase their health. However, why are healthy foods so much more expensive than their unhealthy counterparts? That's where price controls come in: the government can intervene in the market to make healthy foods more accessible. In this explanation, you will learn everything you need to know about price controls. Ready? Then read on!

Price Control Definition

Price control is a form of regulation implemented by a governing body that puts limitations on the price of a good or service. Price controls come in two forms, a price ceiling and a price floor. Price control is explained through the use of a metaphorical price room, where the floor of the room is the lowest price and the ceiling the highest price.

To enact a price control, either a limit to how low the floor can go or how high the ceiling can be must be set. These limits must be set in relation to the equilibrium price to be effective, which is called binding, or an ineffective limit is considered non-binding.

If a price floor, or minimum price, is below the equilibrium price, then there will be no immediate change to the market - this is a non-binding price floor. A binding price floor will be a minimum price above the current market equilibrium, which will immediately force all exchanges to adjust to the higher price.

In case of a price ceiling a price cap is placed on the maximum a good can be sold at. If the maximum price is set above the market equilibrium it will have no effect or be non-binding. In order for a price ceiling to be effective or binding, it must be implemented below the equilibrium market price.

Price control is a form of regulation implemented by a governing body that puts limitations on the price of a good or service.

Binding price control occurs when a new price is set in such a way that the price control is effective. In other words it has an effect on the market equilibrium.

Price Control Policy

An unregulated market can provide efficient outcomes for both supplier and consumer. However, markets are subject to volatility from events such as natural disasters. Protecting citizens from sharp price increases during turmoil is a critical response to minimize the economic damages to livelihood. For example, if prices were to skyrocket for essential products, citizens would struggle to afford daily necessities. Price control can also mitigate future financial burdens as protecting citizens could prevent them from going into bankruptcy and requiring financial assistance from the state.

Common responses to regulation in the market typically range from "why do I care about other people's healthy food access" or "how does this help anything." Both are valid concerns that should be considered, so let's analyze some possible effects a policy like this might have.

If more citizens have healthier diets and thus better health, they are likely to be able to work more efficiently and require less time off work for health issues. How many workplaces have employees who missed work or required short to long-term leave due to preventable health issues? In 2019, the United States government spent $1.2 trillion on healthcare.1 Increasing the health of citizens could reduce the necessity for healthcare spending and allow those tax dollars to be spent on other programs or even allow for a possible reduction in taxes.

Another reason for price controls is that an unregulated market has difficulty addressing externalities. The biggest example is pollution. When a product is created, shipped, and consumed it has varying effects on the world around it, and these effects are difficult to factor into the price. Progressive governments are currently working on regulations to curtail pollution through variations of price control.

Cigarettes lead to diseases like lung cancer and heart disease. Increases in negative health outcomes raise the financial burden for the governments to pay in healthcare costs, therefore the government can attempt to control this by altering the price.

Example of Price Control

An example of a modern form of price control was California's price gouging law which was established in 1994 in response to a major earthquake. This law was designed to be activated in qualifying emergencies that effectively put a price ceiling on specific essential goods. The price ceiling was an interesting modification to the convention method, the law states that the price of the covered goods can't increase more than 10% from the previous month's price. This type of price control is similar to a price ceiling but is more directly a limit to inflation on a monthly basis. The price ceiling is removed when the emergency ends or is altered by executive order.2

Another example of price controls is when the government could try to make healthier food more accessible. To do this a government would need to set the price of healthy foods low. To set the price low, a limit on the maximum price would need to be chosen - this is called a price ceiling.

The free-market equilibrium price of lettuce is $4. At this price 60% of consumers buy lettuce, however, health advocacy groups feel more consumers should have access to lettuce. They lobby the government and the government agrees to set a price ceiling on lettuce at $3. At the lower price, 90% of consumers now can afford to buy lettuce. The price ceiling enabled 30% more consumers to now purchase healthier food.

Price Control Economics Graph

Below is a graphical representation of the two forms of price control and their effects on the supply and demand curve.

Fig 1. - Price Ceiling

Figure 1. above is an example of a price ceiling. Before the price ceiling, the equilibrium was where the price was P1 and at a quantity of Q1. A price ceiling was set at P2. P2 intersects the supply and demand curve at different values. At P2 suppliers will receive less money for their product and therefore will supply less which is represented by Q2. This contrasts with the demand for the product at P2, which increases as a lower price makes the product more valuable. This is represented by Q3. Therefore there is a shortage in Q3-Q2 from the difference between demand and supply.

To learn more about price ceilings check our explanation - Price Ceiling.

Fig 2. - Price Floor

Figure 2 illustrates how a price floor affects supply and demand. Before the price floor, the market settled at equilibrium at P1 and Q1. A price floor is set at P2, which changes the available supply to Q3 and the quantity demanded to Q2. Because the price floor increased the price, demand has reduced due to the law of demand and only Q2 will be purchased. Suppliers will want to sell more at a higher price and will increase their supply to the market. Therefore there is a surplus of Q3-Q2 from the difference between supply and demand.

To learn more about price floors check our explanation - Price Floors.

Economic Effects of Price Controls

Let's explore some of the economic effects of price controls.

Price controls and market power

In a perfectly competitive market, both supplies and consumers are price takers, meaning they have to accept the market equilibrium price. In a competitive market, every firm has an incentive to capture as much of the sales as possible. A larger firm may try to price out its competition to gain a monopoly, which may result in an inequitable market outcome.

Government regulation can intervene by setting a price floor, taking away the larger firm's abilities to lower its prices to drive out competitors. Its important to also consider the full market effect of any policy, a price floor in a competitive market can inhibit innovation and efficiency. If a firm can't lower its price, then it has no incentive to invest in a way to produce its product for less money, this will allow inefficient and wasteful firms to stay in business.

Price controls and deadweight loss

It's important to consider the full economic effects of price controls when implementing them. A change to the market system will affect the whole system and even things outside of it. At any given price of a good, producers determine how much they can supply at the market price. When the market price decreases, the available supply will decrease as well. This will create what is known as a deadweight loss.

If a price control is enacted to make essential goods available to a segment of the population, how can you be sure that the segment you intended it for receives the benefit?

Suppose a government wants to provide affordable housing to low-income residents, so they enact a price ceiling limiting the maximum cost of apartments for rent. As discussed before not all landlords will be able to provide apartments at this lower rate, so supply decreases and creates a shortage. An optimistic view would say at least we got some of the citizens in affordable housing, however, it's important to consider factors of how shortages change the marketscape.

A factor in purchasing an apartment is the travel distance to view apartments and how far of a commute to work or groceries an apartment may require. For citizens with a reliable car driving 30 miles to view apartments isn't that inconvenient, however not all low-income citizens have access to a reliable car. So the shortage is felt worse by those who can't afford to travel long distances. Additionally, landlords have an incentive to discriminate on a tenant's financial reliability, even if legally protected. Low-income housing may not require a credit check, however, when choosing between tenants, a tenant with a high-end car will appear more financially stable than one who arrived on a bus.

Price controls and social programs

Due to the difficulties of shortages when it comes to price controls, many governments have developed social programs that help mitigate the issue of high prices. The various programs are subsidies that help fund goods that are otherwise unavailable to low-income citizens. This changes the dynamic of price control as it takes the burden off the consumer and producer and instead reappropriates tax dollars to aid in the affordability of goods.

The free-market equilibrium price of lettuce is $4. The price ceiling lowered the price of lettuce to $3. With the price ceiling in place farmer Bob is no longer able to sell his lettuce at $4. Farmer Bob grows his crops on lower quality land than other farmers, so he must spend extra money just to keep his lettuce growing. Farmer Bob runs the numbers and realizes he can't afford to buy enough fertilizer with the market price of $3, so farmer Bob decides to grow half as much lettuce. There are a few other farmers like Bob that can't afford to supply as much lettuce at the lower price, so the total lettuce supplied decreases.

Economists generally argue against price controls as the benefits struggle to outweigh the cost. While select individuals or firms may benefit from the price control initially, many will have worse outcomes from shortages or surpluses. Additionally, the precision of aid they are intended to provide is hard to guarantee.

Which term refers to a legally established maximum price that firms may charge?

What is it called when there is a maximum price that can legally be charged for a good or service?

What is the maximum legal price?

What is another name for maximum price in economics?