The Basics of Price Controls
Sometimes it appears that economists don’t agree on very much.
For every economist that endorses a tax cut, for example, it seems like there’s one who will argue against such a change. However, most economists agree that it’s generally not a good idea for government to interfere in the marketplace by setting prices.
Price controls are born out of misguided political impulses, not sound economics. Usually, an industry or group is demonized for charging supposedly exorbitant prices and enjoying too much profit.
Such assertions, though, miss how the market actually functions. Prices and profits work to more efficiently allocate resources by serving as signals. So, high profits will attract more investment and competitors. Increased competition reduces prices and expands choices for consumers. In the end, prices let businesses and entrepreneurs know what to produce and the amount according to the demands of consumers.
When the government sticks its nose into the pricing mechanism, trouble results. For example, a price floor – a point whereby the government dictates that prices cannot fall below – inevitably leads to surpluses. In contrast, a price ceiling – where prices may not exceed a level selected by government – generates shortages.
There are plenty of examples. Agriculture policy often sets price floors, and the result is that too much of a crop is grown.
The minimum wage also is a price floor. The result is that certain parts of the labor force – that is, inexperienced, younger workers – become too costly to employ. Critical work experience is lost, and poverty is perpetuated. For businesses that have no alternative but to hire such workers, costs for consumers rise and business is lost. So, while the minimum wage is supposed to help the poor, it turns out that lower income earners are the group that suffers most.
So, price floors result in unsold goods or services, and wasted resources, including labor.
As for price ceilings, consider the results of rent control. Under rent control, the quality of controlled housing inevitably declines as maintenance becomes too costly, and housing shortages result, as fewer units are built.
In 1973 and 1979, the U.S. capped the price of gasoline. The result was higher costs through long gas lines, as well as reduced incentives for domestic energy development.
A major concern with price controls is the rationing or elimination of the controlled good. Indeed, that brings us to the latest price control push by some in Congress. An effort is under way to allow for the re-importation of U.S.-made prescription drugs from nations that impose price controls. In effect, this would import other nations’ price control schemes into the U.S. Some think the only result would be cheaper drugs – what a deal!
Of course, the result will be far more dangerous. Drug companies will have fewer resources and incentives to invest in new and improved drugs. In the end, a shortage of new medicines will result in fewer illnesses cured and more deaths. Now that is a dire price to pay for government’s meddling in the marketplace.
The market’s pricing mechanism guides what and how much is produced by aligning the demands of consumers with the incentives and abilities for suppliers to produce such goods and services. When government messes with prices, the consequences are messy for everyone – consumers, investors, businesses and employees.
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Raymond J. Keating is chief economist for the Small Business Survival Committee, and co-author of U.S. by the Numbers: Figuring What’s Left, Right, and Wrong with America State by State (Capital Books, 2000).
