CONTROLS ON PRICES

To see how price controls affect market outcomes, let’s look once again at the market for ice cream. As we saw in if ice cream is sold in a competitive market free of government regulation the price of ice cream adjusts to balance supply and demand. At the equilibrium price the quantity of ice cream that buyers want to buy exactly equals the quantity that sellers want to sell. To be concrete, suppose the equilibrium price is $3 per cone.

Not everyone may be happy with the outcome of this free-market process. Let’s say the American Association of Ice-Cream Eaters complains that the $3 price is too high for everyone to enjoy a cone a day (thir recommended diet). Meanwhile the National Organization of Ice Cream Makers complains that the $3 price the result of cutthroat competition is too low and is depressing the incomes of its members. Each of these groups lobbies the government to pass laws that alter the market outcome by directly controlling the price of an ice-cream cone.

Of course because buyers of any good always want a lower price while sellers want a higher price the interests of the two groups conflict. If the Ice-Cream Eaters are successful in their lobbying the government imposes a legal maximum on the price at which ice cream can be sold. Because the price is not allowed to rise above this level the legislated maximum is called a price ceiling. By contrast if the ice cream makers are successful the government imposes a legal minimum on the price. Because the price cannot fall below this level the legislated minimum is called a price floor. Let us consider the effects of these policies in turn.

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