In a market economy, such as in the United States, the price of a good reflects the demand relative to the supply. This is a term known as scarcity.(Ten Things 2015) When an item has a high price it is said to be scarcer than an item of lower price. By looking at the relative prices of an item, consumers and producers can choose how to respond to market scarcity.(Ten Things 2015) Higher prices for example, can lead consumers to choose products that require less scarce resources. The government can play a significant role in a market economy in different ways. One of which is by setting what is called “price controls” on certain products and services. A price control is a maximum or minimum price that a government imposes on specified goods.(Sowell 2011) The most common type of price control is a price ceiling. This is simply when the maximum price is set below the market price. Common examples of price ceilings are rent controls. On the other end of the spectrum is a price floor. This is the opposite of a price ceiling in that a minimum price is set below the market price.(Sowell 2011) A common example of a price floor can be found in the agricultural markets. Price controls have existed all over the world for thousands of years and have applied to almost everything at some point in time.(Sowell 2011) According to economist Thomas Sowell price controls are imposed “in order to keep prices from rising to the levels that they would reach in response to supply and demand”(Sowell 2011) A large topic of interest regarding price control is, what affect does not allowing prices to fluctuate freely according to supply and demand but rather by law, have on the overall market. Most agree that price controls in the long run lead to shortages and surpluses as well as black markets and corruption, however most also agree that in markets where prices are volatile, price controls are a necessary evil. This paper will discuss the advantages and disadvantages of price controls in regards to maximum and minimum price setting, as well as touch on the policies used to implement them.
II. Disadvantages of Price Controls
The disadvantages of price controls can be summed into two different scenarios. Both scenarios while relying on completely opposite regulations, lead to an unbalanced market. The first of the two scenarios is when a price ceiling is imposed. To reiterate this is when the maximum price is set by law to be lower than the market price. The instatement of a price ceiling leads to a fundamental Keynesian problem. By keeping prices artificially low, consumers naturally demand more of the product. When this number becomes greater than the producer is willing to supply we have what is called a shortage. Nobel Prize winner Milton Friedman once said,
”We economists do not know much, but what we do know is how to create a shortage. If you want to create a shortage of tomatoes, for example, just pass a law that retailers can’t sell tomatoes for more than two cents per pound. Instantly you’ll have a tomato shortage”
A market shortage commonly results in one or more of the following negative consequences. Black markets can arise in which products that are unavailable in the regular market are sold.(Price Controls Adv.) This can also be true of products with excess demand that are sold at higher prices than in the conventional market. Black markets often involve non-monetary bargaining methods such as nepotism and violence. Another common result of a market shortage is price discrimination. This is when similar goods or services are priced differently by the same producer to differing regions or groups of consumers.(Investopedia) Essentially this is the practice of charging different prices to different buyers of the same product. Theoretically price discrimination discourages the resale of a good and leads to a decrease in competition.(Investopedia) This is the foundation for a monopolistic economy that does not operate at maximum efficiency. Yet another result of a market shortage is the use of rations, or the controlled distribution of scarce goods and resources. A prime example of when rationing was used is during World War II, when food shortages pushed up prices so high that price controls and rations were used in an attempt to keep the cost of living reasonable. (World War II) Rationing often leads to the emergence of a black market as people seek out goods that are not available in the rationing system. ( The second scenario in the disadvantages of price controls is when the result of a price floor is a surplus. A surplus can be just as detrimental to the market as a shortage. Having an excess supply can result in the market being in disequilibrium. This occurs when the price of a good cannot be adjusted naturally due to price controls. In a state of disequilibrium a market is not operating efficiently. (Price Controls) One example of a price floor that can cause a surplus is that of the labor market. The minimum wage is an example of a price floor, which establishes a base line per hour wage. This can result in employers hiring fewer employees and subsequently the supply of workers exceeds the amount of work available causing the unemployment rate to go up. (Boundless)
III. Advantages of Price Controls
While there is certainly no arguing that in the long run price controls can lead to major economic drawbacks, there is a brighter history in the success of price controls in the short run. Generally speaking price controls can achieve three things. The first is that certain control regulations can ensure that necessary goods, such as food, remain affordable to most citizens. (Boundless) This can also be seen in more luxury markets such as football games. Tickets to important games are often set at a maximum price rather than the market price (which would often times be absurdly high) in order for the common supporter to attend the game.(Price Controls Adv) Secondly price controls can make sure producers receive enough revenue allowing them to adjust to the market climate and limit the possibility of a shortage. (Boundless)This is extremely important in the commodities market where there is frequent fluctuations in price.(Price Controls) Without price controls farmers would experience extreme ups and downs that would not allow for continued production. Price controls can also help during a time when a shortage has taken place. (Boundless)In the latter case price controls prevent producers from overcharging consumers. The most popular form of when price controls helped during a shortage is in the housing market. The use of a rent ceiling put a limit on the amount landlords could charge their tenants when the market would allow for detrimental price gouging. (Rockoff) Another practical example of a necessary price control is the use of a ceiling on interest rates. A ceiling here can take the pressure off of borrowers who were forced to take out loans in a time of desperation that very well could have been caused by the state of the nation.
IV. Analyses of Price Controls
Price controls can be quite tricky to analyze because there are contradictory ways of looking at each individual case. Going back to the football ticket example, while a proponent of price control legislation would argue that a ceiling allows for the common fan to attend games, a critic would argue at the same time that a shortage has been created and less total fans attended the game. Both sides are correct yet one policy must be made. This is a prime example of where long-standing political views collide with market economics. In analyses of the negative impacts of price controls one could argue that without letting a market naturally work its way back to equilibrium then we will never achieve efficiency. This is also where the positive impacts of price control show that welfare and market intervention can increase the standard of living. So it is a choice of whether the government wants to adhere to strict economic idealism and respect the balancing nature of Keynesian economics or if it wants to intervene in order to prevent a possible disaster. I think the answer lies on a case to case basis. For instance in the case for putting a price floor on agricultural products, our country relies on the farming industry for our well-being and survival. Without control of the weather and other exogenous factors farmers often are in need of assistance to survive and I think most economists would argue that the most effective way of helping the would be to have a consistent price floor. In a different case however, such as the pharmaceutical market I believe there should be little government intervention. The danger in such an area is that a proposed price ceiling to make drugs affordable for seniors on Medicare would result in less profit gained by pharmaceutical companies. This would in turn cause a downward trend in their research and innovation spending prohibiting the discovery of new cures and medications. Another example of when a price control wasn’t perhaps the best solution was in the 1970’s when the administration rose the demand for gasoline so high that long lines were found at gas stations throughout the country. (Rockoff) Most would agree that a good as necessary as gasoline, especially at the time, should not inhibit a citizens day to day schedule.
So in conclusion, the amount someone is willing to pay for an item is the items price. From here we derive our basic set of supply and demand functions for our market economy. Essential to the market economy is the term scarcity, demand relative to the supply. Scarcity is what determines the market for goods and services. If the government feels the need to intervene in the market it can implement a price control. The government can approach implementing a price control in two different ways. Price controls are defined as when a government sets a minimum or maximum price for a particular good or service. (Sowell 2011) In the arguments for and against price controls it can be found that most all price controls lead to an inefficient economy in the long run but a possible increase in market stability in the short run. (Sowell 2011) It is up to each administration to decide if government intervention is necessary and most economists agree that it is wise to proceed with the utmost caution when doing so. Price controls when ineffective can result in not only long term disequilibrium, but also negatively affect the day to day life of citizens. (This can be seen in the oil example of the 1970’s.) When effective price controls can protect both consumers and producers, increase market stability, and maintain a reasonable cost of living.(Such as the farming example) In analyses it is best to determine whether a price control should be used on a case by case basis because each market represents different views, challenges, and characteristics. It is important to learn from the past examples of price controls, as they have been occurring for thousands of years, as they will continue to shape not only our financial future but our political future as well.
Boundless. “Arguments for and Against Government Price Controls.” Boundless Economics. Boundless, 03 Jul. 2014. Retrieved 25 Feb. 2015 from //www.boundless.com/economics/textbooks/boundless-economics-textbook/introducing-supply-and-demand-3/government-intervention-and-disequilibrium-49/arguments-for-and-against-government-price-controls-188-12286/
Hugh Rockoff. “Price Controls.”The Concise Encyclopedia of Economics.2008. Library of Economics and Liberty. Retrieved February 25, 2015 from the World Wide Web: //www.econlib.org/library/Enc/PriceControls.html
Parker-Lue, S., Santoro, M., & Koski, G. (2015). The Ethics and Economics of Pharmaceutical Pricing. Annual Review Of Pharmacology & Toxicology, 55191-206. doi:10.1146/annurev-pharmtox-010814-124649
Price controls – advantages and disadvantages. (n.d.). Retrieved February 25, 2015, from //www.economicshelp.org/blog/621/economics/price-controls-advantages-and-disadvantages/
Price Controls: Maximum and Minimum price. (n.d.). Retrieved February 25, 2015, from //www.dineshbakshi.com/ib-economics/microeconomics/161-revision-notes/1766-price-controls-maximum-and-minimum-price
Price Discrimination Definition | Investopedia. (2007, May 17). Retrieved February 25, 2015, from //www.investopedia.com/terms/p/price_discrimination.asp
Sowell, T. (2011).Basic economics: A common sense guide to the economy(4th ed., p. 21). New York, N.Y.: Basic Books.
Ten Things Debaters Should Know About Economics. (n.d.). Retrieved February 25, 2015, from //www.csun.edu/~dgw61315/aboutecon.html
World War II on the home front: Rationing. (n.d.). Retrieved February 25, 2015, from //www.learnnc.org/lp/editions/ww2-rationing/5922