A maximum price is a cap on the price of a good or service, and is a limit on the level that a price can reach. Maximum prices may be set by governments or other agencies
The effect of the lower price for some consumers is to encourage more consumption. Graphically, demand extends, to ‘e’. However, producers will be less inclined to supply at the lower price. Graphically, supply contracts, to ‘f’.
The effect of this is to create a shortage of the good. However, this only happens if the maximum price is set below the market rate. If set above, the market rate prevails.
If we consider this simple example, market equilibrium would be at a price of '4'. Setting a maximum price of three would create a shortage of 400 units.
A maximum price might be set in certain circumstances, including:
The major criticism of setting maximum prices is that it can create shortages. Supply is likely to contract and demand extend so that demand exceeds supply. This is likely to lead to queuing, waiting lists and even 'black' markets.