Price Ceilings and Floors

In modern economies, government always tries to play regulatory roles in the markets. This is important because not only does the government need to safeguard its interests, but it also needs to protect all players in an economy from exploitation. One such way in which the government regulates an economy is by setting of price ceilings and floors. Price ceilings are upper limits for pricing in an economy, while price floors are lower limits for the same prices. In other words, one can describe them as such: Price ceiling is the highest price that is allowed to be charged for a certain good or survive in an economy, while the price floor is the lowest possible price that has been allowed by the government to be charged on any good or service in the economy. Price ceilings and floors are a common phenomenon in modern hybrid economies, where there is a substantial amount of government control, but with considerable elements of market economics. These limits are subject to changes by the governments for a variety of reasons, perhaps the most prominent reason being inflation. Setting of price ceilings and floors is done by central government regulatory organs, like federal banks and government treasury, although it is generally expected that all players in the economy will be consulted before doing so.

Although the idea of setting price ceilings is a good one, even a noble one, there have been a lot of criticisms about it from economists who consider themselves strict classical economists. Many argue that setting ceilings and floors defies the spirit of classical economics, which is that prices ought to be determined solely by the forces of demand and supply. The notion that there is a minimum and maximum price therefore seems to undermine competition and fair-trading in the markets. Well, this argument certainly cannot be dismissed as baseless, but it is true to say that the dynamics of modern economics go far beyond the ideals of capitalism, thus warranting considerable levels of control by the government too. Arguments for price ceilings and floors state that there is need to protect groups such as consumers, who are considered passive participants and are prone to being exploited by unscrupulous businessmen. It would turn out even when there is a perceived prefect competition, sometimes seller of a given commodity may gang up to form a cartel, where they secretly set exploitative prices and behave almost like a monopoly.

But there are some adverse effects of price ceilings and floors too. For example, a price ceiling, when set below the current market prices, may cause some side effects. Here is how.: The consumers suddenly realize that the price for that commodity has reduced, and they decide to buy more of the product, because they now have increased purchasing power. However, producers now find out that they will not be able to earn as much as they used to. As a result, the reduce production, and some even drop out of the market. The consequence of this is that there will be less production and more demand, leading to what economists call a shortage.

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