What happens when you remove a price ceiling in a market?

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greenie1138 eNotes educator| Certified Educator

Let’s first take a look at what happens when you institute a price ceiling. A price ceiling is an artificial cap placed on the price of a good or service that is below the regular market value. (If it were above the market value, it would be called a price floor.) When a government or organization places a cap on the market value of a good, it creates a shortage in the market. If the price of cars, for example, was capped at $10,000, there would be a rush of people wanting to purchase vehicles. At that price, however, car manufacturers will only want to or be able to produce fewer cars because they’re not getting as much money per sale. Thus, with a price ceiling, demand will outweigh supply and there will be a shortage of new cars.

A price ceiling also has other side effects. Say, for example, the government set a ceiling on the price of apartments in Chicago. At $800 for a one bedroom, Chicago would be flooded with renters and there would shortly be no apartments left on the market – a market shortage. In addition to leaving people without the ability to rent apartments, it also creates a net waste. When bedrooms are priced at $800, there are people who would pay $1000 for an apartment and landlords who would happily rent for that price, but they're unable to make that mutually beneficial deal because of the price ceiling. Therefore, there is a $200 wasted potential. The market is not operating efficiently.

Removing a price ceiling returns the market to its natural equilibrium. Due to high demand, prices will rise until the quantity supplied equals the quantity demanded. Some people who were able to afford the $800 apartment will be unable to afford current market rates, so they may have to live outside Chicago where market rates are lower. Overall, removing a price ceiling returns the market to normal operation, which may mean higher prices or lower demand.