When purchasing goods or services, you may run across terms such as “price ceiling” or “price floor”. Because these terms are not used all that often, they can be confusing to those who may hear them on the news or see examples of them when making purchases.
We will explain the definition for both and price floor vs price ceiling examples.
What follows are the definitions of price ceiling and price floor, their alternate names, the similarities and differences between them, and who benefits from having them in place.
Related: Difference Between Net Price and Sticker Price
What is Price Floor and Price Ceiling?
A price ceiling is the maximum amount a seller may charge for a product or service. Another name for price ceiling is price control. This normally means a governing body sets a maximum sales price for goods or services that may be in short supply. The price ceiling is designed to set a maximum amount to avoid price gouging.
Price ceilings may be advantageous in the short term, allowing for the purchase of critically needed items by those who are on a fixed or low budget. However, the long-term ramifications of price ceilings or price controls normally mean that such items run out in a short time. The result is that the item is no longer available for purchase in the area by anyone.
Price ceilings on services are generally different since they normally do not run out as with goods or products. However, a limited amount of time to deliver such services or if necessary, items needed to fulfill the service are in short supply, then a price ceiling may have the same effect as it does on goods.
Example of Price Ceiling
For example, in the early 1970s a gasoline shortage caused a situation in which the US government set price ceilings for the product. The result was that gas prices stopped rising which kept the price within the range of people needing the product. But the downside was that the ceiling only made the shortage worse as gas stations around the country ran out of gasoline.
Another example is rent control, which prevents the rent imposed by a landlord to exceed a certain amount. Rent control is popular in areas in which rental property is scarce. Other examples include caps on prescription drug medications and reimbursements set by insurance companies for medical treatments or procedures.
Example of Price Floor
A price floor is the minimum purchase price set for an item or service. This is sometimes called price support. The price floor represents the lowest legal amount which a service or product may be sold while still operating within the boundaries of supply and demand.
One example of a price floor is the minimum wage. A minimum wage means that businesses and government organizations must pay their employees a minimum amount on an hourly basis. The current minimum wage in the US is $7.25 per hour. This is a price floor since no business or organization can pay less than that amount.
Another common use of a price floor is at auctions. When an item is up for bid, a minimum price is often used so that if the item does sell, it will make some profit for both the seller and auction house. The price floor keeps the item from being sold at an amount so low that it fails to make a profit.
Differences Between Price Floor and Price Ceiling
The most obvious similarity between price floor and price ceiling is that both are types of price controls. They act as a control over how much or how little can be paid for an item or service. Another similarity is that both are normally imposed by government sources, such as at the state, local, and federal level.
However, the differences between price ceilings and price floors are found in their intended effect. A price ceiling is normally done in response to a shortage of items or services. The result is that the price does not soar beyond the means of most people who need such goods or services. While a price floor is normally done to boost growth. By providing a greater income to employees or a higher sale value for an item.
Another difference is that price ceilings tend to be temporary. They are usually imposed in a situation where controlling the price is desired. Once that situation passes, then the price controls are lifted. While a price floor tends to stay in place for longer periods. For example, the minimum wage has been around for decades with no end in sight.
Who Benefits from Both?
There are many who both benefit and suffer from disadvantages when a price ceiling or price floor is imposed. By understanding who benefits, you can better see when such impositions may be applied.
Consumers
In terms of price ceilings, the consumer benefits when shortages of goods or services appear. This means that at least on a temporary basis, the items are available at a price that can be affordable. So, if the products are in stock, the price ceiling offers a definite benefit to consumers.
Of course, that benefit will turn into a disadvantage if the items go out of stock. Rising prices are a control on the supply of the items themselves. The higher the price, the fewer will be purchased. This helps to keep them in stock for consumers who do have the means to obtain them.
Consumers also benefit from a price floor, most notably the minimum wage to name a popular example. Others who benefit include those who sell items at auction as the price floor keeps an item from being sold at a price below profit value.
Business Owner
A price floor benefits business owners selling items or services because when it does sell, it maintains its profitable value. This allows a business owner to feel more comfortable putting items on the shelves or up for sale online knowing that if it does sell, it provides a profit.
Price ceilings and price floors will continue to be a part of the global economy. Their effects both in the short term and long term offer advantages and disadvantages to consumers and business owners.
