In our previous article discussing about price floor, the rationale of price ceiling is fairly similar to price floor – the government deems that the equilibrium price determined in the market is way too high and decides to keep an “artificial lid” below the equilibrium price P0 at Ppc. The word ceiling literally means nothing can proceed “beyond” it!
In 1973, United States suffered high oil prices because of an oil embargo imposed by the OPEC. Since oil is pretty much needed to run on everything, inflation went over the roof, affecting consumers in terms of higher general price level and businesses in terms of higher operating cost. At such, with no immediate substitute for oil and wanting to keep inflation in check, President Nixon chose to impose price ceiling or a maximum price on Gasoline prices. Let us look weigh out the pros and cons of imposing this economic tool:
- Price is kept artificially low, reduces inflation.
However, economists generally do not favour this economic tool because:
- It creates a shortage, where at Ppc, QDD > QSS. In theory consumers are protected from high rising gasoline prices. But in actual reality, this shortage causes long perpetual queues at gaosline kiosks as demand for gasoline are deemed to be fairly inelastic – cars still need gasoline to run no matter what;
- Producers are penalised with an artificial low price and this reduces incentive to produce, further worsening the shortage issue;
- If the implementation of the price ceiling is not strict, this creates a potential black market for gasoline, where gas producers would deliberately horde gas production and charge an exorbitant price to “extort” the consumers who needs gasoline urgently in underground black market..
Basically, the cost outweighs the pros of implementation of maximum price. In my regular classes, I will be using interesting real life examples like this to clearly illustrate economic theories. You can find out more about my JC Econs and Poly Econs services here: