Impact of a price ceiling (maximum price)

After you have worked through this section of the learning unit, you should be able to:

  • explain the impact of a price ceiling on a market

A price ceiling occurs when the government puts a legal upper limit on the price that can be charged for a good or service.

The purpose of a price ceiling is to make certain goods and services more affordable for households. In recent years, price ceilings have been proposed for medication, medical and hospital fees, bank charges and university fees.

While economists tend to disagree on many issues, one of the issues on which they seem to agree is the consequences of rent controls. Rent control is a price ceiling which puts an upper limit on the rent that a property owner can charge.

Many of us rent a room, an apartment or a house to live in. The rent we pay is a substantial part of our income. Do you think the government should impose a limit on the maximum rent that an owner can charge for the use of the room, apartment or house?




If you are a tenant, you may well have said "yes", but if you are a property owner, you would probably have said "no".

If the market operates efficiently, one can argue there is no need for government intervention.

This is the argument we will develop in the rest of the section.

What do you think the impact of rent control on housing would be in South Africa?

Select all the possibilities that you think apply.





All the above effects are part of the consequences of rent controls, which we will analyse in the following sections.

To analyse the impact of price ceilings, we use rent controls on apartments as an example. For the sake of simplicity, we assume that all these apartments are exactly the same.

Market for apartments

Market for apartments

Market for apartments

In the absence of government intervention, the price would adjust in this unregulated market so that the quantity supplied would equal the quantity demanded. This occurs at the equilibrium point E, with an equilibrium price of R3 000 per apartment and an equilibrium quantity demanded and supplied of 30 000 apartments.

Study the following diagram in which the government imposes a price ceiling of R2 000 (Pc) and answer the following questions:

gov excess demand 2000 (4)

gov excess demand 2000 (7)

gov excess demand 2000 (8)

gov excess demand 2000 (10)

  • What is the quantity demanded at a price of R2 000?
  • What is the quantity supplied at a price of R2 000?

From the diagram, we can see that at a price of R2 000 the quantity demanded is 40 000 and the quantity supplied is 20 000.

With the quantity demanded at 40 000 and the quantity supplied at 20 000, an excess demand of 20 000 apartments exits on the market . And this excess demand will persist as long as a price ceiling of R2 000 is imposed on the market. Note that the when a price ceiling is imposed, it does not shift the demand and supply curves. There are movements along the curves.

If one compares this position of an excess demand with the market equilibrium position at point E, the following picture emerges:

At a price ceiling of R2 000 …

  • the quantity of apartments supplied decreases from 30 000 to 20 000 apartments – a decline of 10 000 apartments supplied.
  • the quantity of apartments demanded increases from 30 000 to 40 000 – an increase of 10 000 apartments demanded.
  • an excess demand of 20 000 apartments are created.

At a price ceiling of R2 000, more people would like to rent an apartment but at that price, only 20 000 apartments are available and less people are therefore able to rent an apartment.

What about a price ceiling above the market equilibrium price? Let's assume that the government imposes a price ceiling of R4 000, which is higher than the equilibrium price.

What do you think the impact would be?



A price ceiling is only binding if the price ceiling is lower than the equilibrium price.

If the price ceiling is R4 000 it has no impact because suppliers are willing to supply the market quantity at a price of R3 000, which is lower than the maximum price of R4 000 that they could charge. Suppliers are allowed to ask any price that is below the price ceiling, and as the market equilibrium price is below the price ceiling, renters and owners will settle on the market equilibrium price.

Activity

"Fees must fall"

Use the following diagram of the demand and supply of an economic course at universities to answer the questions below:

Number of students

  1. What it the market equilibrium fee per course?
  2. What is the market equilibrium number of students enrolled for the course?
  3. Are there any unhappy students at the market equilibrium? (An unhappy student is one who is willing to take an economics course but cannot afford to do so at the equilibrium price.)
  4. Are there any unhappy or unsatisfied suppliers in the market at the equilibrium position?
Click to see the answer

1. What is the market equilibrium fee per course?
It is R3 500.

2. What is the market equilibrium number of students enrolled for the course?
It is 15 000.

3. Are there any unhappy students at the market equilibrium? (An unhappy student is one who is willing take an economics course but cannot afford to do so at the equilibrium price.)

Yes. Unhappy students are those who would like to take the course but cannot pay the fee of R3 500. They are able to take the course at a lower fee. They are represented by the portion of the demand curve lower than R3 500.

4. Are there any unhappy or unsatisfied suppliers in the market at the equilibrium position?

Yes. Unhappy suppliers are those who are willing to offer the course but are not able to do it at a fee of R3 500. They are willing and able to supply more at a higher price. They are represented by the portion of the supply higher than R3 500.

Owing to the pressure of students through the "Fees must fall" campaign, the government imposes a price ceiling of R2 500 for a university subject.

Number of students

1. How many students would be willing and able to do the subject at R2 500?
2. How many students can be enrolled at R2 500?
3. With fees at R2 500, is there an excess demand, equilibrium or excess supply in the market?
4. Are there any frustrated students at R2 500? (A frustrated student is one who can pay the ruling price, but cannot find a place.)

Click to see the answer

1. How many students would be willing and able to do the subject at R2 500?
18 000 students.

2. How many students can be enrolled at R2 500?
12 000 students.

3. With fees at R2 500, is there an excess demand, equilibrium or excess supply in the market?

Excess demand. There is an excess demand of 18 000 minus 12 000 students = 6 000 students. As you can see in the diagram below.

4. Are there any frustrated students at R2 500? (A frustrated student is one who can pay the ruling price, but cannot find a place.)

Yes. All those students who are willing and able to pay R2 500 but cannot find a place. In this scenario, there are 6 000 frustrated students (18 000 – 12 000 = 6 000).