Price controls

In the previous episode we talked about prohibition. Although we started with the example of an autistic intervention in the form of a ban on possessing and consuming a substance, we also discussed partially triangular intervention, because since you can’t possess or consume, you also cannot produce or sell. Such a ban on manufacturing and selling is only one type of triangular intervention. It takes place through product control. This section will be devoted to the second type of triangular intervention, namely price control.

The equilibrium price

If we look at the demand and supply curves, there is a point of equilibrium at their intersection. As Dr. Machaj writes in his texbook “Free entrepreneurship” (Wolna Przedsiębiorczość), this is “the point that maximizes trading opportunities at a given moment. This means that it is not possible to carry out more transactions by lowering the price below this point (or raising it). If you lower the price, willingness to buy will increase, but some sellers will give up the sale (because of the lower price). As a result, there will be fewer transactions than with the equilibrium price. It’s also true in the opposite situation: if you raise the price above the equilibrium point, it will encourage sellers to increase their sales, but a higher price will also discourage some buyers. There will again be fewer transactions than there could be at the equilibrium price.”¹

The equilibrium price is the price that clears the market, i.e. balances the quantity demanded with the quantity supplied. Each time the data changes, the market moves towards equilibrium through the actions of entrepreneurs.² We talked more about the process of the determination of prices on the market in our “Price discovery” video.

Intervention

Price control is either setting a minimum price, i.e. below which no one can sell, or a maximum price, i.e. above which no one can sell. The price can also be fixed, i.e. you can only sell at that specific price.³

Mises explains the objectives of such an intervention according to those who propose it:

„In resorting to such measures, the government wants to favor either the buyer – as in the case of maximum prices – or the seller – as in the case of minimum prices. The maximum price is designed to make it possible for the buyer to procure what he wants at a price lower than that of the unhampered market. The minimum price is designed to make it possible for the seller to dispose of his merchandise or his services at a price higher than that of the unhampered market”.⁴

Price control can be either effective or ineffective in influencing the market price. Let’s show this inefficient one with an example. If a kilo of bananas costs a maximum of $2 on the market, setting the maximum price at $10 will not change anything. No one has sold bananas above $2 anyway, let alone over $10. This works the other way around too. If the cheapest new car on the market costs $12,000, then setting the minimum price for new cars at $1,000 will not change anything. No one has ever sold them cheaper than $12,000 anyway. Another example: if the lowest wage rate in the market is $7 per hour, then setting a minimum hourly rate of $3 will not change anything. The negative effects of such regulations are the wasted time of the officials who created these regulations and the wasted paper on which they are written, but they do not affect market prices. Now let’s discuss those that do.

Maximum price

The maximum price affects the market when it is lower than it would be on the market. For example, the market price of a certain good was $10 per kilo, but a maximum price of $6 per kilo was introduced for that good. From now on it is not allowed to be sold for more than $6 per kilo. More people are willing to buy at the new price, but less are willing to sell at that price. There is a shortage. It should be noted that even with a perfectly inelastic supply, if production is maintained at the same level, a shortage will occur. The more elastic the supply, the greater the shortage.

The most visible and perhaps the most burdensome sign of a shortage is queuing. Many people who would be willing to pay the $6 price will not receive the goods. Moreover, many people who would be willing to pay more, for example $10, will not receive it either. The pricing system makes sure that the good goes to the people who value it the most and is disposed of by those who value it the least. This isn’t working during price controls. The good no longer goes to the people who value it the most, so other methods of selection are needed. One of them is the above-mentioned queues and the good is bought according to the “first come, first served” principle. The first in line will get the product, and those at the end will either have to accept the lack of the desired good, or buy it at a higher price illegally, in which case the seller may demand more than $10 because of the risk he or she is taking. There may also be a “sale under the counter” or favoring regular customers, friends or other “chosen ones” while informing other customers that the goods are no longer available. For some goods, such as medical services, bribery may also appear as a way to bypass queues.⁵

Separate consideration may be given to the situation where the maximum price is imposed on a single or several goods and the situation where it is imposed on all goods. The overall negative effects of price control on the economy of individual products will be lesser, but the shortages of these goods will be greater than if all prices were controlled. This is explained by Rothbard’s writing:

„If the price control is “selective,” i.e., is imposed on one or a few products, the economy will not be as universally dislocated as under general maxima, but the artificial shortage created in the particular line will be even more pronounced, since entrepreneurs and factors can shift to the production and sale of other products (preferably substitutes). The prices of the substitutes will go up as the “excess” demand is channeled off in their direction”.⁶

Imposing maximum prices on all goods has more serious consequences. To quote Rotbard again:

„General, overall price maxima dislocate the entire economy and deny the consumers the enjoyment of substitutes. General price maxima are usually imposed for the announced purpose of “preventing inflation”—invariably while the government is inflating the money supply by a large amount. Overall price maxima are equivalent to imposing a minimum on the purchasing power of the money unit”.⁷

Buying goods means selling money. Imposing a minimum price on a unit of money results in people trying to exchange money for something, but they cannot. They are racing to find out who will spend the money faster, because some of the money will not be spent. You can illustrate this by evoking a game of musicalchairs, where there are more people than chairs. In a similar way, there is more money than goods that can be bought by artificially inflating the purchasing power of money. Some of the money will remain unspent and is useless. The only way to use the excess money is to spend it on the black market. Such excess or shortage of money is not possible in market conditions, when the purchasing power of money can adjust to the amount of available goods.

Minimum price

A minimum price is effective in influencing the market when it is set above the level that would be formed on the market. For example, a good on the market costs $10, but a minimum price of $13 is introduced. You mustn’t sell for less than $13, under penalty. In this situation, producers would be more willing to produce and sell more goods if capacity allows, but fewer customers will decide to buy the good at the new higher price. A surplus is created. Here again, it is worth noting that a surplus will arise even with a perfectly inelastic supply and the more elastic the supply, the greater the surplus.

As with the maximum price, the effects of introducing a minimum price for only a few goods will be less severe for the whole economy than the effects of introducing minimum prices for all goods, but the surplus of these goods will be greater.

Similarly, setting minimum prices for all goods will mean setting a maximum price per monetary unit. This will result in a shortage of money in relation to the goods available, and will manifest itself in widespread surpluses, that is, unsold stocks, of all kinds of goods.⁸

Some remarks

It is worth remembering that price control works the same for all prices: wages, exchange rates, interest rates. It is also worth remembering that we are discussing here the introduction of regulations with other conditions remaining constant. There are no other “conditions remaining constant” in a market economy, as it is constantly changing. This does not render this analysis invalid, since the adoption of such conditions is necessary in order to trace the changes caused by a particular factor. This is most easily discussed in the popular example of the minimum wage. In the case of the introduction of a minimum wage, we say that – under other conditions unchanged – it will lead to an increase in unemployment, if it is effective, i.e. it will be set above the lowest wage in the market. However, if we want to analyze a specific case of introducing a minimum wage in a given place and time, we have to consider many additional factors.

Firstly, how much does this distort the market? If the lowest monthly wage in the market is $1200 and the minimum wage is set at $1200 and 1 cent, the negative effects will be so small that they may go unnoticed. If the minimum wage is set well above the lowest market wages, the effects will be more serious.

Secondly, in fact, other conditions will not remain unchanged. A number of different factors, both positive and negative, influence employment levels. Theory of economics says that the introduction of an effective minimum wage affects employment in a negative way, but this is not the only factor that affects it. The analysis should also look at these other factors that influence employment.

Thirdly, we have to consider the fact that regulation is simply circumvented. Entrepreneurs can resort to different ways to avoid raising wages above market levels. Examples are the contractual fees for the use of tools at work or the application of contractual penalties to the employee.⁹

As a result of the above, it can and does happen that we observe a fall in unemployment after the introduction of minimum wage, because the pressure of other factors favorable to the employment level outweighs the adverse effect of the introduction of the minimum wage. It also happens that unemployment has fallen at a rate of e.g. 2% per year, and after the introduction of the minimum wage it continues to fall, but at a rate of 1% per year, in short – it falls more slowly than it did. Therefore, it can be said without making a mistake that in the real economy, where the conditions are constantly changing, the introduction of an effective minimum wage results in the level of employment being lower than it would have been if it had not been introduced, because it is a factor that adversely affects the level of employment.

Summary of effects

It may seem that the maximum price is intended to benefit consumers and the minimum price is intended to benefit producers. However, this is not true for everyone. With a maximum price, some consumers, those ‘first in line’ or those privileged in some way, will gain by buying more cheaply. The rest, however, will be deprived of the opportunity to buy a good, or will pay more for iton the black market. With a maximum price, producers would be willing to sell more expensive, but they will not do so, as demand will be lower. They will stay with unsold surpluses, which will bring them losses. So, something that was meant to serve consumers will harm them and something that was meant to serve producers will put them at a loss. Rothbard reports on other effects of price control:

„Furthermore, price controls distort production and the allocation of resources and factors in the economy, thereby injuring again the bulk of consumers. And we must not overlook the army of bureaucrats who must be financed by the binary intervention of taxation, and who must administer and enforce the myriad of regulations. This army withdraws a mass of workers from productive labor and saddles them onto the backs of the remaining producers—thereby benefiting the bureaucrats but injuring the rest of the people”.¹⁰

We said in the previous film that we will discuss the interventions considering their effectiveness in achieving the goal set by their originators. Mises describes the effects of price control as follows:

„Economics does not say that isolated government interference with the prices of only one commodity or a few commodities is unfair, bad, or unfeasible. It says that such interference produces results contrary to its purpose, that it makes conditions worse, not better, from the point of view of the government and those backing its interference. Before the government interfered, the goods concerned were, in the eyes of the government, too dear. As a result of the maximum price their supply dwindles or disappears altogether. The government interfered because it considered these commodities especially vital, necessary, indispensable. But its action curtailed the supply available. It is therefore, from the point of view of the government, absurd and nonsensical”.¹¹

In one of the following episodes, we will present, on the basis of the example of price control, how one intervention leads to another, and what consistently following the path of successive interventions leads to.

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