Government Intervention: Demand & Supply

1. Price ceiling

When a price ceiling imposed by a government is higher than the market equilibrium price, the price ceiling has no impact on the economy. It does not restrict supply nor encourage demand. In this case, the market is unable to produce a price as high as the ceiling price.

However, in case of a price ceiling below the market equilibrium price, there would be shortage of supply as supplied resources would reduce due to low ceiling price and demand would be larger due to lower price. This creates shortage of supply when the demand increases beyond the ability to supply. This creates a rationing of the product by the market. Some consumers could experience longer lines for the product or no available products when they need or desire to purchase.

An example of this could a ceiling on maximum house rent fixed by government.

2. Price flooring

A price floor is a government-imposed minimum price charged on a good or service to artificially prevents the price from falling too low. When a price flooring imposed by a government is lower than than the market equilibrium price, the price flooring has no measurable affect on the economy. In this case, the market is already producing a price higher than the imposed minimum.

However, in case of price floor higher than the market equilibrium price, pressure on consumers to pay a higher price results in decrease in the demand and even eliminating some consumers from the market. At the same time, this causes producers charge more and results into increase supply. The decrease in demand and increase in supply due to the new imposed higher price creates a surplus of the product. If the government maintain the price floor over a period of time it would aggravate the situation due to increased surplus and government then required measures to absorb the surplus

An example of this could a ceiling on minimum wages fixed by government.

Comparing Price Ceiling & Price Flooring

A price ceiling, in theory, allows consumers to afford the product or service, but can result in shortages and rationing. A price floor keeps prices from falling too low, which can protect producers, but can generate excess supply and waste.

In long run, when markets are not allowed to operate freely, forces build up that tend to bypass regulations, with unintended and undesirable outcomes - aggravates whatsoever (excess supply or shortages) the initial condition further.