A binding price ceiling is a maximum price set by the government a seller is allowed to charge.
Free markets, when left to their devices, tend to achieve a state – equilibrium, in which the quantity supplied by producers will be equal to the amount demanded by consumers. The government sometimes decides to intervene in the markets and control the price of a good with the intention of helping consumers or producers. Price controls, also known as price ceilings and price floors, usually have more negative consequences in the market in which they are being opposed.
There are two types of price ceiling: binding and non-binding price ceilings. The binding price ceiling (Pc) is an effective price ceiling that is below the equilibrium price (Pe), so it binds market forces, preventing the restoration of the market equilibrium. On the one hand, the binding price ceiling is meant to help consumers of a good when they cannot afford to buy it.
For example, the cost per one gallon is $4, and the quantity is 100 gallons of gas. The government decides to get the price for gasoline lowered to $1. If the government reduces the cost, the quantity demanded is going to increase to 200 gallons. At a lower price, consumers will want to buy more gallons of gasoline.
On the other hand, there is an adverse effect of this type of price control. When the price falls, the quantity supplied is going to fall to 50 gallons of gas, because, at a low cost, producers do not want to produce much. If they produce 50 gallons of gas, there is a shortage of 150 ones. As a result, the government’s decision will have a negative impact on consumers because there is less quantity. Instead of 200 gallons of gasoline produced, there are 50 ones. The problem here is the shortage, and the government needs to take action to exclude it in order to restore the balance in the market.