Government Intervention in Markets

Price Ceilings and Price Floors

The government uses price ceilings and price floors to protect consumers, but shifting prices away from equilibrium values can result in deadweight loss.
Price controls are another example of government intervention in the market. A price control is a minimum or maximum price set such that it cannot adjust to equilibrium levels (the intersection of the supply and demand curves). Price controls are regulations imposed by the government that are aimed at protecting consumers and sellers, and they include establishing a price floor or a price ceiling. These interventions happen for policy and social reasons, not to address market failures.

A price floor is the minimum price, higher than the equilibrium price, that a seller can charge for a good or service. Minimum wage is an example of a price floor. Businesses cannot legally pay a worker less than the minimum wage. With a price floor, the market is not in equilibrium: quantity supplied is greater than quantity demanded. Employers pay more for labor than they would at the equilibrium level. This causes a surplus. A surplus of workers implies that there are people who are willing and able to work who cannot find jobs.

A price ceiling is the maximum price, below the equilibrium price, that a seller can charge for a good or service. Rent control is an example of a price ceiling. In this case, rent cannot exceed the maximum price set by the government. Lower rent makes it possible for more people to afford the basic need of shelter particularly in more expensive cities. With a price ceiling, again the market is not in equilibrium: quantity demanded is greater than quantity supplied. Producers earn less revenue than they would at the equilibrium level and supply fewer goods than consumers demand. This causes a shortage.

Price floors and ceilings also create deadweight loss, or loss to the economy or less economic activity than there should be caused by resources being used inefficiently. Equilibrium prices and quantities are determined by the intersection of supply and demand. When supply and demand are not in equilibrium, deadweight loss occurs. Although the reasons for putting price ceilings and price floors in place differ, the resulting inefficiency in both cases is caused by the government imposing a price that is different from the equilibrium price.
A price floor, like minimum wage, sets the price above the equilibrium level. This results in a surplus-in this case, of labor-or the quantity supplied being greater than the quantity demanded. With a minimum wage higher than the equilibrium wage, some people who are looking for jobs do not get hired because companies cannot afford to pay the higher wages. Other companies pay the higher wages, but lose profit. The deadweight loss is this excess burden created by the loss of benefit to consumers and producers.
A price ceiling, like rent control, sets the price below the equilibrium level. This causes a shortage, or the quantity demanded being greater than the quantity supplied. With a maximum rent lower than the equilibrium rent, some people who are looking for apartment can not find one. Thus consumers lose benefits (housing), producers lose profit from the lower rent, and government loses potential tax revenue. The result is deadweight loss or a loss of welfare to society.