Demand curves for many basic but important products or services often have a very different shape or slope than the hypothetical demand curve advocated by traditional economics. Just as a practical example, consider the demand for electricity in many former Soviet bloc nations. A communist government that used poor resource allocation ruled many of these nations for several decades. The result was that electricity was extremely subsidized and often not metered, so that the demand curve had the shape of what appears to be a flat line that increases only slightly with a decrease in price.
The practice of using price ceilings to limit the cost of a product is an example of such a demand curve. Price ceilings are normally used in circumstances where governments fear that the market price would significantly increase the cost of goods or services so that people would be unable to afford them (for example, if electricity prices were to reach levels that would lead to households facing significant hardship). Price ceilings can help limit the cost of goods and services, but they can also act as a bottleneck to efficiency.
When the price is artificially set at a level lower than the potential market rate, sellers may be unable to recoup their costs or turn a profit, even if their product is of superior quality. Such an inefficient market can result in a misallocation of resources, as companies may focus on producing products or services for which there is quite low or non-existent demand, and which can be supplied at prices that are lower than the market rate. If consumers are unable to access the superior products, then the market will be unable to optimize its quality and efficiency.
Moreover, since demand is not necessarily impacted by price ceilings, shortages may occur, as quantity demanded may well outstrip the quantity supplied. This can lead to a lack of access to goods and services, with queues often forming to access basic products and services.
Finally, price ceilings can bring out “gray markets” which operate outside of the official law through unofficial channels. This often means that buyers of goods or services may be exposed to fraud and risk, since these products are supplied in a non- transparent market wherein trust amongst buyers and suppliers cannot necessarily be assured.
In summary, price ceilings can help ensure that goods and services remain accessible for those with limited means but such policies can also limit efficiency and even lead to deficiencies in such goods or services. As such, governments need to carefully consider the long-term implications of imposing price ceilings in order to ensure that the benefits outweigh the potential costs.
