A price ceiling is a government- or group-imposed price control

Question

A price ceiling is a government- or group-imposed price control or limit on how high a price can be charged for a product, commodity, or service. Governments use price ceilings to protect consumers from conditions that could make commodities prohibitively expensive. Such conditions can occur during periods of high inflation, in the event of an investment bubble, or in the case of monopoly ownership of a product.

There is substantial research showing that under certain circumstances, price ceilings can, paradoxically, lead to higher prices. The leading explanation is that price ceilings can coordinate collusion among suppliers who would otherwise compete on price. More precisely, forming a cartel becomes profitable by enabling nominally competing firms to act like a monopoly, limiting quantities and raising prices.

However, forming a cartel is difficult because firms need to agree on quantities and prices, and each firm has an incentive to "cheat" by lowering prices to sell more than it agreed to. A third party, such as a regulator, announcing and enforcing a maximum price level can make it easier for firms to agree on a price and monitor pricing. The regulatory price can be viewed as a focal point that is natural for all parties in the cartel to charge.

Rent controls are a form of price ceiling. These were instituted in the U.S. in the 1940s by President Franklin D. Roosevelt and his newly-formed Office of Price Administration. The Office instituted price ceilings on a wide range of commodities, including rent controls that allowed returning World War II veterans and their families to afford housing.
As predicted by economic models, this policy lowered the supply of rentable properties available to veterans. At the same time, there was an increase in homeownership and the number of homes for sale. This outcome could be explained by landowners converting their rentable properties to sellable ones, due to the financial unviability of the rental market and the lack of incentive for landowners to destroy or leave their properties vacant.

1

Q1. Which of the following is a condition that would most likely trigger a price ceiling?

A. Increased competition among firms in a given market
B. High inflation causing essential goods to become unaffordable
C. Stable prices for commodities in a well-regulated market
D. A monopoly controlling the production and sale of a key commodity
E. Falling demand for non-essential luxury items

2 
 Q2. Which one of the following, if true, would best serve as supporting evidence for the argument that price ceilings can lead to higher prices?

A. Price ceilings were found to reduce the quantity of goods produced by firms in a monopolistic market.
B. Several industries without price ceilings also experience instances of collusion and price-fixing.
C. In markets with price ceilings, suppliers often coordinate with each other to charge prices at or near the maximum allowed level.
D. Price ceilings have historically been used by governments during periods of inflation to control rising costs.
E. Consumers in markets with price ceilings frequently report dissatisfaction with the quality of goods provided.

3 
 Q3. Each of the following describes a problem with price ceilings EXCEPT:

A. Suppliers may collude to charge prices at or near the maximum limit, resulting in artificially high prices.
B. The quantity of goods supplied may decrease as suppliers lose the incentive to produce more.
C. Consumers may struggle to find affordable goods as suppliers withdraw from the market due to financial unviability.
D. Landlords may convert rentable properties into sellable properties, reducing the availability of rental housing.
E. Price ceilings lead to increased competition among suppliers, lowering prices significantly below the ceiling.

4 
 Q4. The author’s writing style indicates that the passage is meant to:

A. Persuade readers to support the implementation of price ceilings in all markets.
B. Criticize governments for using price ceilings to regulate the economy.
C. Explain the potential effects of price ceilings with evidence from research and historical examples.
D. Argue that price ceilings are detrimental to the economy and should be avoided.
E. Present a highly technical analysis meant only for economists or policymakers.

5 
 Q5. Which one of the following best describes the organization of the passage?

A. The passage defines a concept, discusses its theoretical implications, and then provides evidence to challenge the concept.
B. The passage introduces a policy tool, explains how it works under ideal conditions, and discusses cartels and price controls.
C. The passage presents a concept, explores potential unintended consequences, and then supports the explanation with a historical example.
D. The passage outlines a concept, presents several opposing viewpoints, and concludes by taking a stance on the issue.
E. The passage provides an overview of an economic principle, examines multiple case studies, and suggests improvements to the principle.

6 
 Q6. Which one of the following can most reasonably be inferred from the passage about the effects of rent controls?

A. Rent controls directly caused a surge in homeownership by making renting unattractive to tenants.
B. Landlords found it more profitable to sell properties than to rent them under rent control policies.
C. The implementation of rent controls led to the destruction of many rental properties.
D. Rent controls resulted in an overall increase in affordable housing for returning veterans.
E. The goal of rent controls was primarily to increase the number of homes for sale rather than to help renters.

mcrea · Answer

In Q6 I was hesitant between D and B and I chose D in the end.

D seemed to me more inferable because the passage do not saying anything about the actual results of "landowners converting their rentable properties to sellable ones" but it does say that "The Office instituted price ceilings on a wide range of commodities, including rent controls that allowed returning World War II veterans and their families to afford housing"

Can someone explain?

GMATNinja

catinabox · Answer

The passage says 'As predicted by economic models, this policy  lowered the supply of rentable properties  available to veterans.'. If the supply of rentable properties to veterans was reduced, it is unlikely that this resulted in veterans able to afford rental housing, which was the stated goal of the policy- 'The Office instituted price ceilings on a wide range of commodities,  including rent controls  that allowed returning World War II veterans and their families  to afford housing '.

D therefore cannot be correct.

catinabox · Answer

Here are the official solutions:

Q1. Which of the following is a condition that would most likely trigger a price ceiling?

Correct Answer: B. High inflation causing essential goods to become unaffordable 
Option B is correct because one of the main reasons for governments to impose price ceilings is to protect consumers from exorbitant prices, especially during periods of high inflation when essential goods may become unaffordable for the general population.

Incorrect Options: 
Option A (Increased competition among firms in a given market.: This is incorrect because price ceilings are typically imposed in situations where there is insufficient competition, such as in monopolistic markets. Increased competition would naturally lower prices due to market forces, reducing the need for a price ceiling.
Option C (Stable prices for commodities in a well-regulated market.: This is incorrect because stable prices do not require government intervention through price ceilings. Price ceilings are more likely to be implemented in situations where prices are unstable or excessively high.
Option D (A monopoly controlling the production and sale of a key commodity.: Although monopolies can lead to higher prices, this option is incomplete. A monopoly alone doesn’t always necessitate a price ceiling. A price ceiling would be needed if the monopoly results in excessively high prices that harm consumers, which isn’t clearly stated here.
Option E (Falling demand for non-essential luxury items.: This is incorrect because a price ceiling is usually implemented when prices are too high for essential goods, not when demand is falling for non-essential or luxury goods. In fact, falling demand would likely lower prices, reducing the need for a price ceiling.

Q2. Which one of the following, if true, would best serve as supporting evidence for the argument that price ceilings can lead to higher prices?

Correct Answer: C. In markets with price ceilings, suppliers often coordinate with each other to charge prices at or near the maximum allowed level. 
Option C is correct because it directly supports the argument that price ceilings can lead to higher prices by coordinating collusion among suppliers. It suggests that, rather than competing by lowering prices, suppliers coordinate their pricing around the ceiling, which is central to the claim that price ceilings may serve as a focal point for price collusion.

Incorrect Options: 
Option A (Price ceilings were found to reduce the quantity of goods produced by firms in a monopolistic market.: This is incorrect because while it relates to one of the effects of price ceilings (lower supply., it does not address the core argument of the passage—that price ceilings lead to higher prices through coordinated collusion among firms.
Option B (Several industries without price ceilings also experience instances of collusion and price-fixing.: This is incorrect because it focuses on markets without price ceilings. The question asks for evidence that supports the specific argument about markets with price ceilings, so this option is irrelevant to the claim in question.
Option D (Price ceilings have historically been used by governments during periods of inflation to control rising costs.: This is incorrect because, while it provides historical context for why governments impose price ceilings, it does not directly address the argument that price ceilings lead to higher prices through collusion.
Option E (Consumers in markets with price ceilings frequently report dissatisfaction with the quality of goods provided.: This is incorrect because consumer dissatisfaction with quality is unrelated to the argument about price ceilings leading to higher prices. The passage focuses on pricing effects, not quality.

Q3. Each of the following describes a problem with price ceilings EXCEPT:

Correct Answer: E. Price ceilings lead to increased competition among suppliers, lowering prices significantly below the ceiling. 
Option E is correct because it describes a situation where price ceilings increase competition and lead to lower prices, which is contrary to the problems typically associated with price ceilings. Price ceilings generally restrict competition and may lead to higher prices through collusion.

Incorrect Options: 
Option A (Suppliers may collude to charge prices at or near the maximum limit, resulting in artificially high prices.: This is incorrect because it describes a common issue with price ceilings. When firms collude around the ceiling price, they often maintain artificially high prices, which defeats the purpose of the price control.
Option B (The quantity of goods supplied may decrease as suppliers lose the incentive to produce more.: This is incorrect because price ceilings can reduce profitability, leading suppliers to cut production, which reduces the quantity of goods available in the market.
Option C (Consumers may struggle to find affordable goods as suppliers withdraw from the market due to financial unviability.: This is incorrect because when price ceilings make markets financially unviable for suppliers, they may reduce supply or withdraw, making it harder for consumers to find goods even if prices are controlled.
Option D (Landlords may convert rentable properties into sellable properties, reducing the availability of rental housing.: This is incorrect because the passage discusses how rent controls, a form of price ceiling, can reduce the supply of rental housing as landlords find selling more profitable than renting under price controls.

Q4. The author’s writing style indicates that the passage is meant to:

Correct Answer:
C. Explain the potential effects of price ceilings with evidence from research and historical examples. 
Option C is correct because the passage primarily aims to provide an objective explanation of price ceilings, illustrating both potential benefits and drawbacks, with evidence from research and historical contexts like rent controls in the U.S. This aligns with an explanatory purpose, rather than one of persuasion or criticism.

Incorrect Options: 
Option A (Persuade readers to support the implementation of price ceilings in all markets.: This is incorrect because the passage does not attempt to persuade readers to support price ceilings; it simply explains how they function and their effects, both positive and negative.
Option B (Criticize governments for using price ceilings to regulate the economy.: This is incorrect because the author does not take a critical stance against price ceilings or government policies. The passage is more neutral, focusing on explaining their outcomes rather than criticizing their use.
Option D (Argue that price ceilings are detrimental to the economy and should be avoided.: This is incorrect because the passage does not argue against price ceilings. It mentions some negative effects, but it does not explicitly argue that price ceilings should be avoided.
Option E (Present a highly technical analysis meant only for economists or policymakers.: This is incorrect because the passage, while discussing economic concepts, is written in a way that is accessible to a broader audience and is not overly technical or limited to economists.

Q5. Which one of the following best describes the organization of the passage?

Correct Answer: C. The passage presents a concept, explores potential unintended consequences, and then supports the explanation with a historical example. 
Option C is correct because the passage starts by explaining the concept of price ceilings, then discusses unintended consequences (such as higher prices due to collusion among suppliers., and finally uses a historical example (U.S. rent controls in the 1940s. to support and illustrate these points.

Incorrect Options: 
Option A (The passage defines a concept, discusses its theoretical implications, and then provides evidence to challenge the concept.: This is incorrect because the passage does not aim to challenge the concept of price ceilings. It provides an explanation of the concept and describes both positive intentions and unintended negative outcomes, but it doesn’t present evidence that challenges or refutes the validity of price ceilings.
Option B (The passage introduces a policy tool, explains how it works under ideal conditions, and discusses cartels and price controls.: This is incorrect because the passage does not explicitly focus on how price ceilings work under ideal conditions. Instead, it explains the intended purpose of price ceilings and primarily discusses unintended consequences like collusion and its impact on prices, rather than contrasting ideal versus non-ideal outcomes.
Option D (The passage outlines a concept, presents several opposing viewpoints, and concludes by taking a stance on the issue.: This is incorrect because the passage doesn’t present opposing viewpoints or take a firm stance. It is written in an objective and explanatory tone, discussing the concept of price ceilings and their consequences without favoring one viewpoint over another or drawing a final conclusion.
Option E (The passage provides an overview of an economic principle, examines multiple case studies, and suggests improvements to the principle.: This is incorrect because the passage does not examine multiple case studies, nor does it suggest any improvements to the principle of price ceilings. The passage uses only one historical example (U.S. rent controls. and does not propose reforms or improvements to the policy tool.

Q6. Which one of the following can most reasonably be inferred from the passage about the effects of rent controls?

Correct Answer:
B. Landlords found it more profitable to sell properties than to rent them under rent control policies. 
Option B is correct because the passage indicates that landlords converted rental properties into sellable ones due to the financial unviability of renting under rent control. This implies that landlords saw selling as a more profitable option than continuing to rent under the constraints of price ceilings.

Incorrect Options: 
Option A (Rent controls directly caused a surge in homeownership by making renting unattractive to tenants.: This is incorrect because the passage does not suggest that tenants found renting unattractive. Instead, the decision to reduce the number of rental properties was driven by landlords, not by tenant behavior.
Option C (The implementation of rent controls led to the destruction of many rental properties.: This is incorrect because the passage makes no mention of properties being destroyed. It only discusses the conversion of rental properties into sellable properties.
Option D (Rent controls resulted in an overall increase in affordable housing for returning veterans.: This is incorrect because the passage specifically states that rent controls reduced the supply of rental properties, making it harder for veterans to find affordable rental housing. The increase was in homes for sale, not rental units.
Option E (The goal of rent controls was primarily to increase the number of homes for sale rather than to help renters.: This is incorrect because the passage clearly states that rent controls were intended to help returning veterans afford housing by keeping rents low, not to increase the number of homes for sale. The increase in homes for sale was an unintended consequence, not the primary goal.

mcrea · Answer

This is so obvious, I cannot believe I made such a careless error...
Can you provide difficulty level for these questions? Thanks!

bb · Answer

Looks like this is a MEDIUM difficulty passage, approaching Medium High at 605-655 level so to speak. This is the old 650-700.

A price ceiling is a government- or group-imposed price control

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GMAT Reading Comprehension (RC) Questions

A price ceiling is a government- or group-imposed price control

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