Price ceiling – The maximum price that the seller can charge on specific goods. Price ceiling is a price control mechanism mostly used by the government to protect consumers.
Price floor – This is the minimum price that the seller can charge on a good.
Equilibrium price or Market clearing price – This is the market price at which the quantity demand is equal to the quantity supplied.
When is price ceiling binding and what are effects on consumer surplus and producer surplus?
A price ceiling is binding only when it is set below the market equilibrium price. Otherwise, it would make no sense to set a maximum price that is above the current market price as it wouldn’t affect demand or supply in any way. By setting a price ceiling below market-clearing price, the producer surplus increases.
Producer surplus is defined as the difference between the minimum price the seller is willing to accept and the actual price.
A price floor is binding only when set above the market-clearing price. Otherwise, setting a minimum price that is already below the market-clearing price would yield no effects. When the price floor is set above the market-clearing price, the consumer surplus decreases.
Consumer surplus is defined as the difference between the maximum price the consumer is willing to pay, and the actual price.
Buyers of gasoline would lobby for a price ceiling to prevent overcharging, while the seller would lobby for a price floor to prevent the prices going down beyond a certain level.
