Price Ceiling

In countries like India essentials of life, like certain food grains or life saving medicines, are often found to be extremely scarce.

Their prices are often found to be high. Poor population found it difficult to buy them. Such a situation often compels the government to intervene in the market with Price Ceiling. 

It means fixing a maximum price for a commodity which is generally much below the equilibrium market price.

Ceiling means maximum limit. Price ceiling means the maximum price of a commodity that the seller can charge from the buyers for a particular good and service. It is also termed as Maximum price Legislation.

Price Ceiling Policy

Let us understand the implication of price ceiling policy through the below graph.

Price Ceiling

DD and SS are the demand and supply curve respectively. OP is the equilibrium price and OQ is the equilibrium quantity. E is the point of equilibrium.

If ceiling is imposed above the equilibrium price (at OP₁), it has no effect on price and quantity.

At OP₁ there emerge a situation of excess supply (GH- surplus) which will pull down the price and quantity to the equilibrium E.

So ceiling should be imposed below the equilibrium price. If the ceiling is imposed on price OP₂, it will leads to a situation of excess demand (KL- shortage).

Quantity demanded at price OP₂ is OQ₂ and quantity supplied is only OQ₁.

A shortage of commodity will develop in the market equal to KL.

The quantity actually bought and sold will be OQ₁.

A situation of ‘partial hunger’ may continue to exist. The government must find a remedy to this situation.

Rationing of the commodity is often found as a remedy. Each family is allotted a fixed quota of commodity.

Fair price shops are opened as outlets for rationing. People are distributed ration cards.

They go and buy their allotted quota of commodity from these shops.

But, Price ceiling with rationing is not totally free from its adverse impact on the consumers.

Some of them are:

1) Standing in long queues

2) Low quality product

3) There is a pilferage from the ration shops. Essential commodities, though meant for the poor, often find a way to the black market.

Black market is a market in which goods are sold illegally at prices higher than a legally fixed price by the government.

It occurs due to shortage of goods at the price fixed by the government.

There are some consumers who are willing to pay a higher price to get extra quantity (more than the quantity rationed) and sellers to gain sell it to a price higher than the price fixed by the government.

Black marketing compounds the problem of scarcity and keeps poorest of the poor in a state of deprivation.

If a price ceiling with rationing is to succeed, the government must improve upon its distribution system.

Floor Price

Floor means the lowest limit. Price floor means the minimum price fixed by the government for a commodity in the market. It is also termed as Minimum Price Legislation.

Floor price also termed as minimum support price benefits the suppliers of a good or service.

The floor price is fixed to assure the producers that they would get a remunerative price for their product.

The floor price will motivate the producers to produce more by ensuring that they will get a minimum reasonable price for their product.

A poor farmer in India grows wheat partly for self consumption and partly for sale in the market. The harvest time is almost same for all the farmers, and storage capacity is poor.

So farmers sell their produce immediately after harvest. Consequently, there is glut in the market and the price crashes.

Even when the harvest is good, income of the farmers tends to reduce.Such a situation may discourage the farmers to grow as much wheat as before.

To avoid hardship of the farmers and scarcity of the wheat, the government resort to floor price, a minimum price is fixed which the trader must pay the farmers in the wholesale market.

Thus income of the farmer is regulated and continuous production of wheat is assured.

Floor price Policy

Let us understand the implication of Floor price policy through the below graph:

Price Ceiling

DD and SS are the demand and supply curve respectively.

OP is the equilibrium price and OQ is the equilibrium quantity.

E is the point of equilibrium.

If minimum price is imposed above the equilibrium price (at OP₂), which is lower than equilibrium price, it will have no effect on the market. At OP₂ there emerge a situation of excess demand (KL- shortage) which will push up the price and quantity to the equilibrium E.

So floor price should be imposed above the equilibrium price.

If the ceiling is imposed on price OP₁, it will leads to a situation of excess supply (GH- surplus). Quantity demanded at price OP₁ is OQ₁ and quantity supplied is only OQ₂.

A situation of surplus will develop in the market equal to GH.

The quantity actually bought and sold will be OQ₁.

Some producers may find it difficult to dispose of their product at legally fixed minimum support price.

So to dispose of their unsold stock, they will sell their goods at lower price (lower than floor price).

In order to ensure the minimum support price, government buys this surplus (at minimum support price) and stores it in buffer stocks (these stocks are meant to be used during the periods when current supply of food grains falls short of its current demand).