Price change ceiling
- 1 Definition
- 2 Examples
- 3 Justification
- 4 Types of price change ceiling
- 5 Short-run impact of price change ceilings: they can lead to binding price ceilings in the face of demand and supply shocks =
- 6 Long-run impact of price change ceilings
A price change ceiling is an upper limit placed by a government or regulatory body with government sanction on the rate at which a price can be increased. It is a variant on the concept of a price ceiling.
- The most common and widely used example of a price change ceiling is the vacancy decontrol form of rent control, where a cap is placed on the year-over-year growth in rent for a given rental agreement between a buyer and a seller, although there is usually no absolute cap on the amount of the rent. When the tenant leaves, a new rent may be set for the new tenant.
- Some stock markets have ceilings on how much the price of a stock can change in a given day, in order to reduce rapid variation in prices.
- Price change ceilings may be imposed to prevent price gouging during emergencies.
The following are typical reasons for price change ceilings:
- Reduce the incidence of sellers exploiting buyers through lock-in.
- Reduce volatility and increase predictability in the market.
- Address potential problems of price gouging.
Types of price change ceiling
Classification based on what "price" means
- Price change ceiling applied to the market as a whole: Here, no seller is allowed to sell at a price more than some percentage higher than the market price at some point in the recent past (e.g., no seller is allowed to sell at more than 10% of the average price in the market last week).
- Price change ceiling specific to a seller: Here, the price a seller is currently selling at is compared to the price the seller sold at in the past.
- Price change ceiling specific to a pair of buyer and seller: This makes sense in the context of a repeat transaction. Rent regulations of the "vacancy decontrol" form are like that -- the rent of a given housing unit is allowed to increase at some maximum annual rate for a given pair of landlord and tenant, but once the tenant moves out, the landlord may give the apartment out for rent at any price.
Classification based on how "change" is bounded
- An additive price change ceiling is a ceiling based on the (additive) difference between the price and the previous price. For instance, an additive price change ceiling of 3 currency units per unit of the good means that if the previous price is 10, the new price can be at most 13, and if the previous price is 100, the new price can be at most 103.
- A multiplicative price change ceiling is a ceiling based on the ratio of the price and the previous price. For instance, a multiplicative price change ceiling of 20% means that if the previous price is 10, the new price can be at most 12, and if the previous price is 100, the new price can be at most 120.
Classification based on the time periods between price changes
The reference "previous price" may be calculated as the price as of the previous day, or previous week, or previous year. If price varies continuously, a convention may be used, such as taking the end-of-day price, or average price across the day.
Short-run impact of price change ceilings: they can lead to binding price ceilings in the face of demand and supply shocks =
A sudden demand shock or supply shock can cause the equilbrium, market-clearing price of a good to increase a lot, more than the price change ceiling allows. At this point, the price change ceiling functions as a uniform fixed price ceiling in the short run, and has the same short-run static analysis.
Long-run impact of price change ceilings
A price change ceiling is non-binding in the long run if the rate of change of the market price is expected to always be less than the price change ceiling.
A price change ceiling is binding in the long run if the rate of change of the market price is expected to, at least sometimes, be more than the price change ceiling.
In this section, we discuss binding price change ceilings; non-binding price change ceilings should have very little impact on buyers or sellers.
Binding price change ceilings, when specific to pairs of buyer and seller, create a lasting contractual relationship between them, which can lead to smoothing of price increases over the years
When a binding price change ceiling is specific to a pair of buyer and seller, such as in the case of vacancy decontrol, it effectively gives the buyer a long-term ownership stake in the relationship (in the form of price guarantees over the coming year). Exiting the relationship costs the buyer as the buyer now needs to search for another relationship, at a possibly higher price than the sheltered, ceilinged price.
The seller may therefore factor this into the initial price for the buyer. Knowing that the seller will be locked into restricted price increases for possibly a long period of time, the seller may therefore charge a larger initial price than they otherwise would.