Maria Beirouti 20180107

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Government Policy (Price Ceiling and Price Floor)

Government policies are principles or rules that are put to be a guide for better decisions.

Governments try to set minimum or maximum prices. By using price controls, the

government will force a market or a business to work at a disequilibrium. Price controls limit

the price a product or service can sell at. Conflict often surrounds the prices and quantities set

by demand and supply, particularly for goods which are considered necessities. Price ceiling

and price floor are two ways in which the government controls prices. Price ceiling is defined

as the maximum legal price for goods and services. On the other hand price floor is the

minimum legal price imposed by the government on goods and services. Both price controls

can only be regulated by the government when there is unfairness in prices.

Price Ceiling:

Price ceiling prevents a price from rising above a certain level causing shortages (excess

demand). It is only effective when set below the equilibrium price. It is a situation in which

quantity demanded is greater than the quantity supplied.

An example on price ceiling would be the price of bread in

an attempt to protect the poor. The government sets a

maximum price for bread so that all citizens could afford to

buy it since it is a necessity for all people, therefore no

bakery can exceed this certain price.

Another example is; during the crisis of coronavirus, the government imposed price ceilings

on the egg commodity in an attempt to keep prices low for those who demand the product

since eggs are a necessity for most people. When the market price is not allowed to rise to the

equilibrium level, quantity demanded exceeds the quantity supplied, thus a shortage occurs.

Price ceilings on eggs are also imposed so that everyone can afford buying them, as well as

preventing sellers from taking advantage of the crisis and raising the eggs prices, leading to a

shortage of eggs.

Example 3:

The Graph below is an example of a price ceiling rent control, where the intersection of
demand and supply occurs at E0. Unless a price ceiling stops the prices from increasing, the
shift in demand from D0 to D1 results in a new equilibrium at E1. The quantity demanded rises
to 19,000 after the change in demand, causing a shortage.

Price Quantity Supplied Original Quantity Demanded New Quantity Demanded

$400 12,000 18,000 23,000
$500 15,000 15,000 19,000
$600 17,000 13,000 17,000
$700 19,000 11,000 15,000
$800 20,000 10,000 14,000
Price Floor:

Price floor is the exact opposite of price ceilings. It prevents a price from dropping below a

certain level causing a surplus (excess supply). It is only effective when set above the

equilibrium price. Governments set price floors for a variety of reasons, but the main one is

due to increased supply and decreased demand. Thus, it is a situation in which quantity

demanded is less than the quantity supplied.

Since products with a price floor are higher, fewer buyers will likely be interested in buying

affected goods at the required minimum price level. This will result in a surplus of products

available for sale, in accordance with the increased demand.

When set above the market equilibrium price, this ensures

that customers would be obliged to pay for goods or

services more than they would if prices were based on the

free market standards.

The market would continue to operate at its equilibrium if

the price floor is set below the equilibrium price.

An example on price floor would be minimum wages. As

governments impose minimum wages that firms can’t go below. For instance, in Jordan,

employees should be paid a minimum of 220 JDs. As a result, all firms / organizations should

abide by this policy.

Example 2:

The Graph below is an example of a price floor, where the quantity demanded and quantity
supplied are equal at E0, with the price P0 and quantity Q0. The price above E0 is where the
price floor lies (Pf) and stops it from dropping down. The effect of the price floor is that the
amount supplied Qs overreaches the amount demanded Qd. This causes excess supply,
known as surplus.