Price Control 

We’re going to talk about a good idea that started with good intentions, and how then it seems that they can go completely wrong. 

Price controls can destroy markets. And subsidies can alter them negatively. And “deadweight” isn’t just a good description of your ex. 

Let’s say John becomes president and he puts a cap on all the prices of consumer goods. He says that the lower price will help everyone from the poor to the middle class even small businesses so practically everyone. A few people might fall for this policy, but not you. You're funny and smart and attractive, and you understand why this is a terrible idea. This example seems imagined or delusional, but sadly, it actually happened.

 Instead it was President Richard Nixon. In the 1970s, Nixon established a 90 day price and wage freeze designed to fight inflation among other things to help the economy. The general public supported the idea, but economists were skeptical. A famous quote came from distinguished economist, Milton Friedman, he called the freeze “one of those ‘very plausible schemes…with very pleasing commencements, [that] have often shameful and lamentable conclusions’”. (Friedman, 1971, pp. 22). Economists call this idea of the government setting prices, price controls. There's two types and we're gonna go through both of them.

PRICE CEILINGS

When the government sets a maximum price for a specific good or service, that’s a price ceiling. Let's say the government forced gas stations to charge a dollar per gallon for gas. This might seem like a good idea, right? Mandated lower gas prices mean we all benefit. Not really. Society is actually made worse off. When the gas prices fall consumers will want to buy more, but producers will no longer find it profitable to sell gas. The lower price will decrease the amount of gasoline produced, and we've got a shortage.

PRICE FLOORS

A price floor is a law that sets a minimum price in a specific market. The idea is to help by keeping the price artificially high and not allowing the price to fall down to equilibrium which was talked about in another tab so I hope you understand. Let’s make up an example using corn. Assume the government set a price floor for a bushel of corn at $7 when the actual equilibrium price is $4. The higher price would give farmers an incentive to produce more, but, at that high price, consumers would go buy substitutes -- things like wheat or rice. Instead of cornflakes they'd buy rice krispies. The point is, the farmers wouldn’t necessarily be better off. They could sell corn at the higher price, but they wouldn’t have as many customers. 

ACTUAL USE?

In terms of actually helping consumers and producers, the vast majority of economists consider price controls counter-productive. But there is one notable exception: minimum wage. But I won't get side tracked.

Let’s look at both these policies again using the supply and demand graph. Assume the equilibrium price for gas is $3 and the government sets a price ceiling here, at only $1. At that low price, consumers would want to buy more. The producers have less incentive to produce gas so they're going to make less. The end result is that the quantity bought and sold is going to fall resulting in a shortage. The amount of gas society wants is where supply meets demand. Producing any quantity less than that will result in something that economists call deadweight loss. So the quantity produced at the price ceiling is not allocatively efficient. We're not producing enough. The lower the price ceiling, the more the deadweight loss and inefficiency. Keep in mind that the price ceiling only has and effect on the market when it's below the equilibrium price.

REAL WORLD EXAMPLES

Many countries still use price ceilings: take Venezuela. In recent years they have been experiencing high inflation, so the government decided to impose price controls on consumer products like basic foods, medicine, and toilet paper. But, the new price is so low relative to the cost of production that farmers and factories can't make money. As a result, they've reduced or halted production of many goods, causing long lines, shortages, and empty shelves.

Rent control is another type of price ceiling. Many cities, including New York and San Francisco, put a cap on monthly rent for some apartments. Again, the idea is to increase affordability for tenants, which enables long-term tenants to stay in their homes when real estate prices rise. Meanwhile, the lower rent discourages renovation and new construction, reducing the quantity supplied. The result is a shortage of apartments with landlords that have few incentives to maintain their buildings or be responsive to their tenant’s needs. Economists are not at all split on rent control. Pretty much all of them think that price ceilings on rent reduce the quantity and quality of the housing that's available. 

Now, how about a price floor? Well, look at corn with an equilibrium price of $4 per bushel and a price floor at $7. The higher price will give farmers an incentive to increase the quantity supplied. But, consumers don’t want to pay those higher prices so the quantity demanded is gonna fall. The result is a surplus and deadweight loss, so society's worse off. Now one argument for a price floor on corn is that if farmers can’t get a high enough price, they'll stop producing. Then we will run out of food and die. Economists are not fans of starvation so they recognize that the government needs to get involved sometimes to preserve our food supply. But they don't use price floors. They use subsidies but I wont get off topic.

TAKEAWAYS

Now, government policies like price ceilings and floors often fail to make all of us better off. Sometimes, markets fail. And that's when the government needs to step in.

(Mankiw & Taylor, 2020)