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How do price ceilings, price floors, deficiency payments, and other artificial controls...

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kristenmarieb... | Student, Grade 10 | Valedictorian

Posted June 8, 2013 at 3:09 PM via web

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How do price ceilings, price floors, deficiency payments, and other artificial controls over price undermine the effectiveness of the price system?

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justaguide | College Teacher | (Level 2) Distinguished Educator

Posted June 8, 2013 at 3:33 PM (Answer #1)

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Controlling price with the use of price ceilings, price floors, deficiency payments and the alike have a lot of disadvantages in the long run. Free pricing with adequate competition and no restriction either on the upper end on the lower ensures the optimal use of resources. 

This is not the case when the price is controlled artificially. For example, if a price ceiling is used for the benefit of consumers, sellers are restricted from increasing the price above a particular level. The result is many producers stop production as they are no longer able to make profits. The drop in supply leads to a shortage and many consumers would not be able to buy the product in spite of the price kept at a low level. On the other hand, if a price floor is used, the price of the product has to be kept above a particular level. Here, the demand decreases as many customers are not willing to buy the product at the higher price. The result is an excess supply, producers are left with only a small number of consumers for their products.

If the price is allowed to change freely based on demand and supply, to maximize profits it becomes essential for producers to use the most efficient methods for production. Consumers also do not have to face any shortages.

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