Question

“Price ceiling is the maximum legal price that can be charged in a
market ”. Explain why a “price-ceiling policy” can reduce
social welfare? Explain the implications
the business?

Answer 1

Price celling is generally done by the governments due political pressure or to care for the every people in the economy. Price celling has a large impact on social welfare as well as in business.

In some circumstances, the government believes that the free market equilibrium price is too high. If there is political pressure to act, a government can impose a maximum price, or price ceiling, on a market.

Price Ceiling = A maximum price policy to help consumers.

A price ceiling is imposed to provide relief to consumers from high prices. In food and agriculture, these policies are most often used in low-income nations, where political power is concentrated in urban consumers. If food prices increase, there can be demonstrations and riots to put pressure on the government to impose price ceilings. In the United States, price ceilings were imposed on meat products in the 1970s under President Richard M. Nixon. Price ceilings were also used for natural gas during this period of high inflation. It was believed that the cost of living had increased beyond the ability of family earnings to pay for necessities, and the market interventions were used to make beef, other meat, and natural gas more affordable.

Price ceilings are often imposed on housing prices in US urban areas. Rent control has been a longtime feature in New York City, where rent-controlled apartments continue to have low rental rates relative to the free market rate. The boom in the software industry has increased housing prices and rental rates enormously in the San Francisco Bay Area, Seattle, and the Puget Sound region. Rent control is being considered in both places to make San Francisco and Seattle more affordable for middle-class workers.

Welfare Analysis

Welfare analysis can be used to evaluate the impacts of a price ceiling. In what follows, we will compare a baseline free market scenario to a policy scenario, and compare the benefits and costs of the policy relative to the baseline of free markets and competition. Consider the price ceilings imposed on the natural gas markets. The purpose, or objective, of this policy was to help consumers. We will see that the policy does help some consumers, but makes other consumers worse off. The policy also hurts producers.

This unanticipated outcome is worth restating: price ceilings help some consumers, but hurt other consumers. All producers are made worse off. This outcome is not the intent of policy makers. Economists play an important role in the analysis and communication of policy outcomes to policy makers.

The baseline scenario for all policy analysis is free markets. The quantity of natural gas is in trillion cubic feet (tcf) and the price of natural gas in in dollars per million cubic feet (USD/mcf).

Social welfare is maximized by free markets, because the size of the welfare the Consumer surpluss+ Producer surplus is largest under the free market scenario. As we will see, any government intervention into a market will necessarily reduce the total level of surplus available to consumers and producers. All price and quantity policies will help some individuals and groups, hurt others, and have a net loss to society. Policy makers typically ignore or downplay individuals and groups who are negatively affected by a proposed policy. Price ceilings can also create deadweight loss by discouraging production and decreasing the supply of goods, services, or housing below what consumers truly demand. Consumers experience shortages, and producers earn less than they would otherwise.