Price Controls

During the summer of '08, back when gas prices were peaking and Exxon was making evil profits (the same profits that have somehow kept them out of the Bailout Boondoggle, interestingly enough) I heard my boss remark that we needed to go back to the 1970's and institute price controls again. It simply wasn't fair, he said, that they should charge that much for gasoline. Let's examine price controls and how they work, and what the evidence is.

Price controls are attractive at first glance. Ceilings are instituted to help some portion of the population that is seen as victims, who struggle to meet rising prices of a given product. Floors are put in place to make sure that a group of producers (farmers, for example) get a "fair" price for their goods.

Economists are generally opposed to price controls, because they distort the allocation of resources. Placing a ceiling on wheat, for example, below where the market price currently stands, will cause a shortage. At the lower price, producers will not make as much wheat, but demand will increase because wheat got cheaper. The result is a shortage in the market. Remember the gas lines in the 1970's? That was a shortage. Other effects can be even more damaging.

Take the line itself. Gas was served on a first come, first serve basis. Economically, the true cost of gas now included the gas itself and the time spent waiting. I'll wager that if price controls were not present and there were no lines, the true cost would have been lower. The cost will reach equilibrium, and it can't be arbitrarily controlled.

Quality deterioration is a frequent effect. If a landlord is forced to rent units below the market price, he will not idly accept the redution in profit. He will cut costs. Maintenance on the building will go down. During WWII in the U.S., due to price controls, more fat was included in hamburger meat, candy bars got smaller, and so on. The market will react, and it is arrogant to think the gov't can "control" it. Because price controls distort the market, other mechanisms like these will form.

But this was supposed to help the public, right? Take another example. Let's say a clothing manufacturer has a low-priced product with a small profit margin, and a high-priced product with a high profit margin. If the gov't sets up a price ceiling and creates a shortage, the clothing maker is likely to discontinue to low-profit line. The public now only has the choice of the higher priced clothes. This also happened during WWII, and the gov't then tried to force the manufacturers to keep making the cheaper clothing even though gov't policies clearly made it a bad business decision.

Let's step back even further. I'll take an idea from economist Thomas Sowell. Beach front housing is attractive, and expensive. Demand exceeds supply, and the price reflects that. It is therefore "unfair", because beachfront property goes disproportionally to those who can afford it. Let's say the gov't sets all beach front property at $100 per acre. Not one extra foot of sandy beach has been created. There is no more supply of the commodity. The allocation used to be controlled by prices, but now something else must control it. There is not enough space for every person who desires the ocean to live on the beach, so the gov't must decide who gets what space, since they assumed the role of controlling it.

Is this more fair? There will still be a limited number of people who can enjoy the beach, but now it is decided by a select group of people, with absolutely no bias, no tendency for corruption, and infinite knowledge on the matter they now pretend to control. Would you prefer this to letting millions of individual decisions, based upon each person's preferences, judgement, knowledge allocate the resource? Which gives more power to a few, and which to the many? Which allows for more freedom?

When I used to sell Volkswagens, we had a diesel model of the Jetta. It got 45 mpg. During the gas crunch of 2005, demand skyrocketed. We couldn't keep them in stock. We started raising prices, and the public threw a fit. The MSRP was supposed to be a magic ceiling! Why, how could we sleep at night after "gouging" people? Gouging is a term used by people when supply and demand do not go in their favor.

If gas were $.10 per gallon, and they bargained for a discount on a Jetta, that wouldn't be gouging the dealer, would it? On the contrary, they think that since supply far outpaces demand, that the price should drop. It works the same way in reverse.

The problem lies in a misunderstanding of prices. They are not a final reality, they merely convey what lies beneath. Knowing how prices work is crucial to understanding the rest of economics.