What is the price ceiling?

Price ceilings are restrictions placed on how much a seller can charge for a product, commodity or service. They are used by governments to protect consumers from high costs and are especially implemented for essential items like fuel, rent, food and medicine. 

The price ceiling definition by Cambridge Dictionary describes it as “an upper limit set by a government on the price that can be charged for a product or service”.

However, price ceilings could negatively affect the economy. What does the price ceiling mean? Read on for an explanation of the idea behind the maximum price restrictions. 

Price controls are economic policies that have been undertaken throughout human history. The Code of Hammurabi has documented how Babylonians controlled wages over 4,000 years ago. During World War II, western countries implemented price ceilings on items such as meat and cheese to fight inflation and shortages.

There are two types of price controls: price ceilings and price floors. Price floors are most commonly associated with minimum wages. Price ceilings are commonly implemented to make essential items affordable for consumers.

How does the price ceiling work?

Periods of high inflation have prompted governments to impose price controls. However, economists have long questioned the long-term effectiveness of price ceilings.

“Price controls have costs whose severity depends on the broadness of the control and the degree to which it changes the price from the free-market price,” said the Federal Reserve Bank of St. Louis (FRBSL).

It added that “competition shifts from production to political markets as firms attempt to influence price-setting decisions” and goods and services are allocated inefficiently when price ceilings are implemented. 

Price ceilings are not efficient inflation-fighting policies as “suppressed inflation appears when temporary controls are relaxed,” according to FRBSL. Furthermore, price ceilings encourage sellers to tap into illegal black markets to evade price limits. 

FRBSL also stated that price controls tend to work better in monopolistic and “imperfectly competitive markets.”

“Price controls have had a very long but not very successful history. Although economists accept that there are certain limited circumstances in which price controls can improve outcomes, economic theory and analysis of history show that broad price controls would be costly and of limited effectiveness.”

Price ceiling explained

Price restrictions on medicines, present in various countries, is a widely used price ceiling example. In India, the government has set price ceilings on a set of essential drugs. Price control legislation on drugs and active pharmaceutical ingredients in the country goes back to the 1960s. Today, India’s drug price ceiling is based on the World Health Organisation’s (WHO) list of essential medicines.

According to the Centre of Global Development, India’s price ceilings have benefited consumers through declining prices but have also harmed them through “exit of low-cost producers, and producer exit from rural areas.”

Price ceilings on drugs can also discourage companies from introducing new drugs to the market and on research and development (R&D) efforts from firms due to the expectation of limited profits.

Elsewhere in the New York State, US, there are rent controls present in some municipalities. In New York City, the Division of Housing and Community Renewal determines a maximum base rent and a maximum collectible rent for each individual rent controlled apartment.

“Rent control applies to residential buildings constructed before 1 February 1947 in municipalities that have not declared an end to the postwar rental housing emergency. There are several municipalities that still have rent control in effect. These include New York City, Nassau, and Westchester counties. In New York City, rent control tenants are generally in buildings built before February 1, 1947, where the tenant is in continuous occupancy prior to 1 July 1971,” read the official New York State website.