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The U.S. economy operates largely on market principles, but there are many instances in which government intervenes to head off the effects of a truly free market. One way it does so is through price controls -- price floors and price ceilings. The difference between them is whether the government is setting a minimum or maximum price for something. If you have employees, you're already familiar with at least one kind of price control.
Price Floors
When government imposes a price floor, it's setting a minimum price for a good or service. Most businesses in the country have to contend with the most familiar price floor: the minimum wage. Government has said that there's a certain minimum price employers must pay for labor. Price floors are common in agricultural commodities such as milk or corn, where the controls are designed to protect farmers' income. Governments also use tariffs and trade taxes to set price floors on imported goods as a way of helping domestic companies compete.
Price Ceilings
A price ceiling is the opposite of a price floor: It's a government-mandated maximum price for a good or service. As economists Paul Krugman and Robin Wells note in their basic text "Microeconomics," price ceilings are far less common than price floors in the modern U.S. economy. Still, there are some. Rent-control law in New York and other major cities is an example of price ceilings. Medicare essentially sets price ceilings when it specifies a maximum price the program will pay for medical procedures or supplies; providers can charge more, but doing so may preclude them from accepting the tens of millions of people on Medicare.
Intentions
Price controls are intended to protect one group, and that protection typically comes at the expense of others. Price floors guarantee income for sellers while raising costs for buyers. Price ceilings, meanwhile, keep costs down for buyers while limiting sellers' income. However, both also can have what Krugman and Wells refer to as "predictable and undesirable side effects." Whether a price control has such side effects depends on the equilibrium price -- that is, the price that a good or service would command in a free market if there were no price control in effect.
Floor Effects
If the minimum wage for labor is $7.25 an hour, but qualified workers are so scarce in your area that you have to pay $15 an hour just to get someone to take a job, that price floor is irrelevant. Price floors have an effect only if the floor is set above the equilibrium price. When that happens, sellers are getting more money for their goods and services than the market thinks they're worth. This leads to overproduction and oversupply. This is one reason why the federal government buys surplus food and gives it to the poor or to schools.
Ceiling Effects
Price ceilings have an effect only if the ceiling is set below the equilibrium price. When that happens, sellers are getting less than what the market would give them. This discourages production or pushes producers into the black market. At the same time, buyers are getting a great deal, so they snap up what little does get produced. Shortages result. Soviet-bloc economies set artificially low price ceilings, and store shelves there were empty while black markets flourished.
Source: Small Business Chron
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