Price Controls

Things being what they are, politicians and people often tend to resort to artificial, coercive price controls whenever they feel they're caught on the short end of the stick.  Of course, this often wreaks havoc with the economy, if only proportional to the severity of the price control, and leads to irrational stories, crazy situations and absurd spending priorities.  For example, government price supports to agriculture cause the federal government to buy surplus foodstuffs that are often thrown away and to pay farmers to NOT grow anything to keep supply down.

Of course, humorous stories aside, price controls can really affect people - whether poor people who have to pay more for bread and milk or small businesses that have to see profits squandered.  Let's go into a very basic lesson of economics here.

This is your basic supply and demand chart.  These vary greatly and sometimes demand is steeper or flatter, sometimes the graphs are curved, etc.  For simplicity's sake, we assume an approximate X shape.

This is the optimal price (P*) and optimal quantity (Q*).  Notice how the intersection of supply and demand is the determining point for finding price and quantity.  Notice also that the variables involved are not wholly independent of each other; changing one variable necessarily affects another.  This is important when we see the effects of boneheaded laws.

Suppose some Congressman decides that corn farmers - who just by coincidence happen to reside in his district - deserve more money for their corn.  He doesn't like the laws of supply and demand, so he's decided to ignore them.  To do this, he institutes a price control; in this case, it's a price floor.  Now all of a sudden the corn farmers in the Congressman's district are making more money for the same old thing; more people are producing corn because it's more profitable than other agricultural goods.  Unfortunately, demand for corn is the same (or perhaps even lower given the recent price increase) so even fewer people want corn.  The result is that at least temporarily more corn will be produced than is bought.

The green colored section of the graph is the oversupply of the product.  If the price control were a minimum wage instead of a corn price floor, the excess labor would be unemployment.  In other words, raising the minimum cost of labor cools demands and causes unemployment.

Ultimately, raising the cost of labor forces businesses to make up the difference.  In practical terms, this means one or all of the following: hiring fewer workers, firing unaffordable workers, cutting back on training, cutting back on benefits to afford new workers, raising the prices charged by consumers.  This is especially hard on small businesses, which often have much smaller budgets and tighter profit margins.

What about the reverse situation?  If a price ceiling is enacted, most commonly with rent control or the price of bread in developing countries, then it causes the opposite problem.  The green in this instance is a dearth rather than an excess.  It means not enough people are producing to meet demand, especially with demand heightened by the lowered price.

In this case, if I were a baker when the price of bread is dictated to be low, I would rather operate somewhere I could sell at a higher price or rather sell goods that were not artificially lowered.  So price ceilings tend to cause shortages, as in the French Revolution after price controls came around.  If I were a real estate developer when the price of rent is dictated to be low, I would rather build housing somewhere I could sell it for a higher price, like the suburbs.

In the case of oil and gas, it was Nixon's price controls that caused the shortages.  By limiting the price that people could pay and by other rationing techniques, Nixon broke the laws of supply and demand.  This created a shortage and the ensuing gas lines.  General mismanagement, fear-mongering and the reserve allocation also contributed to the crisis-shortage mindset, but the price-setting itself caused the shortages.  When Reagan came to office he eliminated price controls (though Carter had loosened it a little) and as a result there were no more shortages.

Supply and demand ultimately give us a few principles: when something is priced too high, the result is a shortage; when something is priced too low, the result is a surplus.  This means that the minimum wage, rent control, agricultural price supports and gas price controls are all going to alter the basic ability to buy and sell goods.

The problem is those with a mindset of "this costs too much," or "these people should make more," who then decide to alter the price of goods and services.  They ought to instead approach with the mindset of "what's the most efficient way to do this," or "what's the best way to make sure goods and services are bought by the people that need them," before they set to work.  If they simply followed the rules of the market then they could see most shortage and surplus situations could be avoided; in general more needs would be met and in a more efficient manner.