A price ceiling is one example of the government regulating the market prices of goods and services. There are advantages and disadvantages to price ceilings, and we’ll discuss these, along with the effects and how to set the right price for your product or service.
Let’s start with the price ceiling definition.
According to Investopedia, a price ceiling is the mandated maximum amount a seller is allowed to charge for a product or service. Governments and other regulatory bodies impose price ceilings when they believe an item's supply and demand price is unfair. The price ceiling amount is typically below the market equilibrium price (the price a consumer is willing to pay for a good or service), so it’s effective.
A price ceiling is a type of price control that prevents sellers from charging more than the ceiling price. This ensures that as many consumers as possible can obtain or retain access to the products or services because they aren’t prohibitively expensive.
The examples below illustrate price ceilings for a variety of products and services. Hopefully, these will enhance your understanding of how a price ceiling works in real-life situations.
Let’s say you live in an apartment building in New York City, where the cost of rent can be astronomical. Your building, however, is subject to rent control, so your rental rate is limited. Rent control either limits the maximum cost that can be charged for your apartment or sets the maximum percentage your rent can be raised each year for the apartment.
After Hurricane Sandy hit the Northeast US in 2012, New York and New Jersey set price ceilings for essentials like bottled water. This ensured that everyone had access to clean drinking water during recovery from this crisis.
Food and fuel price caps
Some governments may enforce a price ceiling on essentials like food and fuel to ensure access and prevent profiteering (i.e. black market).
Prescription medications and lab tests
The government can set maximum pricing for some medications and laboratory tests to ensure that all people have access to them. In the US, the Inflation Reduction Act of 2022 includes provisions to lower prescription drug costs, including ceilings on out-of-pocket expenses over the next several years.
Medical insurance companies usually set maximums on how much they will pay out to doctors or reimburse patients for medical treatment. These maximum reimbursement rates could be considered price ceilings.
In addition to setting price ceilings, the government can set price floors. Price floors are the literal opposite of price ceilings. Let’s look at how they’re the same and how they’re different.
As we’ve covered, the price ceiling is the maximum amount a seller can charge for goods or services as set by a government or other regulatory body.
As the opposite of a price ceiling, the price floor sets a minimum purchase price for a product or service. Setting a price floor can help an industry avoid producing surplus products. The price floor is typically set above the market equilibrium price. This can benefit producers, farmers, or factory owners by setting higher minimum prices.
Minimum wage laws are the best examples of price floors. The minimum wage sets the lowest legal amount that an employer can pay a worker so that the worker can afford a basic standard of living.
The following are the steps a government or regulatory body typically takes when setting a price ceiling:
Price ceilings are typically imposed on consumer staples like food, gas, or medicine, especially after crisis events that may cause prices to increase dramatically on these items.
If the market equilibrium price increases and demand exceeds supply, a shortage could result.
While a price ceiling is helpful in the short term at stimulating demand, long-term use has ramifications.
A deadweight loss is the cost to society, which occurs when supply and demand are out of equilibrium. This leads to goods and services being either over or undersupplied to the market. With the resulting inaccurate pricing, there will be changes in consumer behavior that can negatively affect the economy.
If the price ceiling is too high, overvalued products may equal higher profits for a business but put consumers at a disadvantage in obtaining what they need. And if the ceiling is too low, undervalued products may become very desirable for consumers, but producers may be unable to meet production costs.
As an example, let’s look at a taco vendor. If the vendor makes 100 delicious tacos but only sells 75, they must discard the 25 that will go bad. That oversupply is their deadweight loss.
If that same taco vendor makes 100 delicious tacos, sells them all, and has 15 customers still waiting to buy tacos, this is another example of a deadweight loss because the customer is willing to make the purchase, but can’t due to a lack of supply of tacos.
There are advantages for both consumers and sellers when a price ceiling is enforced.
In the short term, price ceilings keep goods and services affordable for consumers. They prevent sellers from taking unfair advantage and charging exorbitant prices. If a temporary shortage is causing inflation, ceilings can keep prices within an affordable range for consumers until supply increases.
When prices are kept to an acceptable level, it encourages consumers to spend as they take advantage of lower prices. This is a positive sign for the overall economy.
Price gouging occurs when sellers take unfair advantage of consumers. This can happen during an emergency or disaster situation if a seller significantly increases the prices for essential goods or services. Price ceilings prevent sellers from raising prices to unreasonable levels and allow consumer access to necessary products.
Of course, along with the advantages of price ceilings, we may also experience disadvantages.
Price ceilings are placed below the equilibrium point where supply and demand meet so that the product or service is affordable for the consumer. Well, this affordability creates higher demand. Because of the ceiling, producers can’t always set prices high enough to supply products without experiencing a loss. If this happens, they either stop producing the products or go out of business. This results in a shortage of those goods or services. Using our taco example from earlier, let’s say the price of flour escalated quickly. The vendor may not be able to afford to create tacos and stay under the price ceiling.
If lower prices don’t result in a shortage, it may be because businesses are cutting costs so they can make a profit at the lower price point. Cutting costs can mean cheaper materials, unreliable products, or poor quality. If our taco vendor cuts corners, he may buy inferior-quality cheese or meat. These cost-cutting measures will affect the taste and quality of his tacos, and they will no longer be as desirable to the public.
When price ceilings create excess demand, consumers want products but cannot purchase them. If legal suppliers can’t meet the demand, consumers may buy the products they want at a higher price than the price ceiling allows from illegal sellers. Returning to our tacos, this means consumers can still get their delicious tacos, but only if they are willing to pay an inflated price.
So, let’s say your business produces goods that are affected by a price ceiling. How do you set your prices? Momentive, the maker of SurveyMonkey, has an answer.
The Van Westendorp Price Sensitivity research method was introduced in 1976 by Dutch economist Peter Van Westendorp to determine consumer price preferences. Van Westendorp analysis is used widely in market research to determine the price points for products and services.
Conducted through a survey, respondents are asked a series of questions to determine what value they place on a product or service.
The questions vary, but typically read something like this:
These questions basically ask what is too expensive, too inexpensive, and a good value for the product or service in question. The answers are plotted on a graph to identify the indifference price point (the intersection of expensive and cheap) and the optimal price point (the intersection of the “too cheap” and “too expensive” lines).
With this information, you can make an informed decision about what consumers are willing to pay for your product or service within the price ceiling, if applicable.
SurveyMonkey offers a price optimization tool that may be used to identify the optimal price point and price range for a product or service with direct input from your target market. The experts at SurveyMonkey will help you obtain high-quality data through a skillfully designed study using the Van Westendorp Price Sensitivity solution.
TIP: Need help creating a price testing survey? You can use the price testing survey template by SurveyMonkey to get started.
It can be difficult to find the optimal price for your products and services, especially if you’re operating in an environment with a price ceiling. Price ceilings and floors can be both helpful and harmful, depending on the situation. So, price your product with confidence using the Momentive Price Optimization Tool.