Price Controls in the Economy - Essay Example

Price Controls Introduction Price controls are government interventions in the economy used to regulate prices. The intention behind developing price controls is to retain the affordability of products, prevent price increases during shortages, and to reduce the rate of inflation (Wise, 12). That is; price control is a form of government intervention in the country’s economy whereby the government agency utilizes its law-making power to regulate the prices at which otherwise voluntary private exchanges may take place. The two principal forms of price control are price ceiling and price floor (Newberry, 02). Price ceiling refers to the highest amount that can be charged for a product. Ceiling price controls determines the highest prices that might be charged for a particular commodity but do not limit transactions at lower prices below the ceiling price. On the other hand, price floor is the minimum amount charged for the product. However, just like in the case of price ceilings, price floor controls do not limit transactions at higher prices above the floor price (Newberry, 09). The government agency may be encouraged to fix and enforce the exact prices for which certain commodity or commodities may be sold. Alternatively, the government through the agency-as discussed above-might decides to set ceilings and floor prices for particular goods or services. The market prices determined by the interaction of the demand and supply curves are the basic building blocks for most economies. Consumers taste for a commodity will determine how much of the product they will be willing to buy at a given price. Consumers tend to buy more of a commodity as its prices declines (Newberry, 87). Companies in turn, decide on how much they will be willing to supply to the market at different prices. If consumers agree to pay more for a commodity, then more suppliers will be tempted to produce the product. The increased prices motivate manufacturers to increase their production capabilities by conducting research to improve the quality of the products. Therefore, the supply of goods in the market increases with an increase in the product’s price (Wise, 32). This dynamic interaction provides the equilibrium market price of the commodity where sellers and buyers can transact freely. The price that results from this interaction causes the quantity of goods being demanded by customers to be equal to the supply produced by manufacturers. In most countries, the government is going through hard times trying to control prices for some commodities. For instance, one of the critical issues that were facing American citizens by the year 2001 was how to manage prescription drug prices, particularly for senior who depend on Medicare coverage. Some policy makers at the time tried to encourage the government to directly contract with drug manufacturers to purchase drugs for the seniors-at the government set prices. However, despite numerous attempts by the policy maker, that kind of price control proved to be harmful to the American citizens. Considering the above example and many other similar cases, this paper will try to analyze the problems associated with price controls (Wise, 145). 2. Constitutional Issues affecting Price Control It is a common practice that every government will always gain favor from the voters and its constituents when it lowers prices of any popular commodity (Age?nor and Carlos, 89). That is, prices to some extent limit the welfare of an individual as it will reduce the amount of products consumed. Therefore, lowering the price will definitely increase the welfare of consumers especially if the prices are for popular good within a country. The government also gains favor from firms and lobbyists when it raises prices of some goods-that will earn them profits. Given these benefits to policymakers, you should not be surprised on discovering that price control is a common practice in history of most Western economies (Age?nor and Carlos, 102). Constitutional law, in the effect of national power, is compounded of equal parts of economics and procedure. On questions of price controls, the vital argument is whether safeguards have been established which tend to assure reasoned and arbitrary action. The power to control the inflationary rise of prices is a power to avoid the resultant economic disintegration (Breyer, 201). Some constitutions states that the power to prevent economic dislocation which threatens the practical success of basic constitution should not be regarded as peculiar power (Marke, 77). The classical economics claims that unregulated economies may have some few individuals or firms having a competitive advantage over the majority hence causing a major fail in the economic systems (Nathanson and Harold, 04). The success of price controls would otherwise have been endangered by the dislocation of the market. Presently, price control is a function of complex network of economic controls and therefore should be given many considerations it deserves. In regards, to the constitution purposes, price controls should be considered as an adjacent to other measures taken during the monetary and fiscal policies implementation (Nathanson and Harold, 123). When the government implements a price control mechanism, it sets the market price of a commodity and forces a significant percentage of the economy’s transactions to be undertaken at that price rather than the equilibrium price set by the interaction of supply and demand (Marke, 15). In contrast to demand and supply of a commodity that varies in response to costs and preferences, government prices will only change after lengthy political processes. This means that the government price is not an effective equilibrium price because it is usually set either too high or too low the equilibrium market price (Age?nor and Carlos, 29). When the price of a commodity is extremely high, there will be an increased amount of goods for sale as compared to what consumers want. This condition is common among most European and American farm programs. The government, in an attempt to improve farm incomes, buys the goods that people do not need. This, in turn, results in the farmers to raise more livestock and transform more land to pasture and cultivation lands. However, the raised prices discourage people from buying farm products resulting in the excess supply of farm products (Nathanson and Harold, 61). The government then worsens the condition by continuing to buy the excess products at the set price. Severe problems are also observed when the government sets the prices lower than the equilibrium level. This condition attracts more consumers into buying the products more than manufacturers can produce. The system of priorities and allocations of vital materials should be complemented by a well defined price control. Such controls will serve to correct the injustices flowing from distribution of scarce resources among the consumers. In addition, price controls will try to correct bootlegging and other forms of evasion (Marke, 21). Price controls are an adjunct also of the power of the government to requisition and to negotiate purchases contracts. Some economies require price controls so as to eliminate the dual system of prices. The dual system of prices is a situation whereby two pricing system would prevail; one for the government-achieved by agreement or fixing of fair market value- and the second one is for the private sector, which is more speculative in nature. According to Nathanson and Harold (156), the most constitutions dictate that consumers need not to pay prices which reflect artificial enhancement. Those constitutions lay down the principle of a single regime of prices for government and the public. Allowing the private sector to make profits in the expense of citizens’ welfare is just intolerable. The problem with this type of governance is that the market might fail if the government takes full control price setting. It is for these reasons that, most governance have amended their current constitutions to incorporate a mixed economy; whereby the government will intervene only if the market fails attain equilibrium through the forces of demand and supply (Marke, 155). 3. Economic Logic of Price Controls Governments have been on the forefronts to set minimum or maximum prices of commodities since ancient times. The Israelites were forbidden from taking interest on loans from their fellow Israelites, in the Old Testament. During that time, the medieval government was also involved in setting the price of bread. In recent years, the U. S government has been involved in fixing the price of gasoline, wages of unskilled labor, and rent on apartments. The government, at times, goes beyond setting the prices and tries to control the overall level of prices (Nathanson and Harold, 150). This measure was seen during the first and second world wars in the U.S. The appeal to control prices is understandable. Although, they do not successfully protect most customers and hurt others, price controls still hold out to protect groups that are oppressed by the price changes. For example, the provision against usury, that charged more interest rate on loans, was established to protect an individual who was forced to apply for a loan out of desperation. The maximum price of bread was also set to cater for the poor, who relied on bread to survive (Nathanson and Harold, 10). However, despite the common use of price controls and their appeal to regulate prices, economists generally oppose these measures except for short periods during emergencies. According to a survey conducted in 1992, 76% of the economists interviewed agreed that ceilings on rent reduce the quality and amount of housing facilities available. The reason why most economists are cynical about price controls is that these regulations distort the distribution of resources. Price ceilings that inhibit prices from surpassing a certain maximum price may cause commodity shortages. Price floors that hinder prices from going below certain minimum prices may result in surplus goods (Rockoff 1). The incentives that businessmen take to elude government controls are numerous and may come in various forms. The precise measurement relies on the nature of goods and services produced by the manufacturer or organization. Quality deterioration is one of the forms of evasion. The government may enact quality deterioration by advocating specific product standards (Nathanson and Harold, 190). 4. Literature Review The need for price control is understandable. Even though they fail to protect many consumers and hurt others, price controls is implemented on the basis of protecting groups that are particularly challenged in meeting price increases. In recent years for example, the government of the USA have fixed the prices of gasoline, the wages of unskilled labor, the apartment’s rents among others. In some situations, governments exceed fixing specific prices and try to control the general price levels as was done in America during the 1st and the second wars, and by President Nixon’s administration between 1971 and1973 (Campbell, 67). Prices that are freely set by the market play a significant role in regulating an economy. They allow businesses to be informed about the services and commodities that are of most value to their customers (Breyer, 140). They also alert them on the management materials, methods, and technologies to apply so as to obtain maximum economic benefits. By extending the prospect of profits, price regulations, provide each firm with an incentive to innovate, invest and to offer goods that are more valuable to the consumers. The economists are opposed to price controls and they only encourage price controls during emergency periods. In a survey published in 1992, 76.3% of the economist respondents agreed with the statement that” A ceiling on rent reduces the quantity and quality of the available housing.” another 16.6% agreed with the qualifications and just 6.5% were against the statement. The results of the survey were similar when asked about general price controls: only 8.4% agreed with the statement that wage/prices controls is a very vital option when tackling inflation as an economic problems (Campbell, 90). Most economists are against the price controls because they believe that they distort the allocation of resources. Their argument is supported by Milton Friedman statement that: “economists may not know much, but they do know how to produce a shortage or surplus. Price ceilings, which prevent prices from exceeding a certain maximum, causes shortages. Price floors, which prohibit prices below a certain minimum, cause surpluses, at least for a time” (Rockoff, 88). Price controls update consumers about the scarcity of resources used to produce or provide the various goods and services they are consuming. For instance, when the price of a commodity increases, this not only signifies the manufacturers will be profitable by producing more goods but also enlightens the buyers to use less of the product and reduce their waste (Campbell, 86). Because controls prevent the price system form rationing the available supply, it is necessary to put in place some mechanism. For instance, a queue which was once a familiar method of controlling prices in Economies in Eastern Europe can act as a possibility (Campbell, 66). The 20th Century provided many examples of economic problems related to price controls in communist Europe. Economist David Tarr revealed that some of these problems while studying distribution of domestically produced television sets in Poland-as a communist state (Rockoff, 53). Because the government of Poland at that time enabled low prices for the TV sets, demand exceeded the supply and the result was scarce televisions. Those who were in need of a TV set had to sign on to a waiting list. Rockoff (67) reveals that in most instances, the buyer had to visit the store everyday just to make sure he/she stays on the list. According to Tarr’s calculation, the social cost of the queue for the television sets was 10 times the size of the standard deadweight loss and hence the price control costs of TV sets to the Polish economy was more than the industry’s total sales (Rockoff, 71). It is not in the communist nation that price controls effects were felt. In the late 80s, Japan’s Ministry of Finance regulated brokerage fees and prohibited companies form competing for customers on that basis. As economists Young Park and Kevin Hebner explained, large corporate customers were played a vital role f or the securities dealing of the industry (Campbell, 195). Therefore, the implementation of the price controls enabled the industry to find other corrupt ways to compete for corporate business (Newberry, 17). For example, the corporate investors would be guaranteed by the securities firms that certain funds would achieve a minimum return, and that the investor would be refunded effectively if the investment declined in value. This expensive practice was funded by the securities firms, mainly with the profits earned from the government fixed exchange for brokerage for both the large and the small customers (Campbell, 206). As a result, the securities firms were able to turn the price control scheme into a transfer scheme which was characterized with the movement of resources from household savers to large corporate investors (Newberry, 29). Firms are very slippery when it comes to competition; such that if the government prevents them from competing over price, then they will find another dimension in which to compete (Newberry, 22). When the Civil Aeronautics Board was left to set the prices during the U.S airline regulation, airlines tried to attract customers with food, frequency of flights and empty seats. This competition mechanism can be as expensive as competing on the price. It is for this reason that established carriers competed away their rents thereby not earning high returns, despite high prices and protection from new entrants. General Price controls is often perpetuated when the public becomes speculative of an increase inflation rate. In the 20th C, war had sometimes been the occasion for general price controls (Schuettinger et al. 14). In such scenarios, the argument could be that controls have a positive psychological benefit that exceeds the costs, at least in the short run. Increasing inflation may lead to panic buying, animosity towards minor races and tribes who are perceived to the beneficiaries of the increased inflation, strikes and many others (Breyer, 13). Price controls can be useful in correcting these economic stresses, especially if patriotism can be counted on to limit evasion. This was the limiting case for price controls as stipulated by Frank W.Taussig. In his famous essay “Price-Fixing as seen by a Price-Fixer,” Frank argued that it is the inflation that is being forced down if the government undertakes a price control and this is significant (Schuettinger et al. 56). Towards the end of the 2nd World war, several leading economist among them Frank H. Knight and Henry Simons, wrote to the New York Times calling on the Congress to continue with their act of price controls for another year until the equilibrium was obtained in the economy. This would ensure that the country is protected form inflationary spiral that might arise if the controls were removed suddenly (Schuettinger et al. 66). However, it is worth noting that all problems with price controls-black markets, evasion, queuing, and rationing-raises the real pries of commodities, and these effects are only partly taken into consideration during the computation of price indexes. Keynesians economists argue that it is much difficult to control inflations through general price controls. This is partly because; it becomes hopeless to limit control to a manageable sector of the economy. In his book in “A Theory of Price Control,” which was based on his experience as deputy administrator of the Price Administration in the 2nd World War, Kenneth Galbraith argued that it was easier to control prices of goods produced by large industrial oligopolists (Rockoff, 99). This is because these firms had large number of administrators who could be convinced to do the task. He overstated the market power of large firms, of which many of them were in highly competitive industries. However much Galbraith was right; the problem with limiting controls to particular sector is that with increasing demand, the prices in the uncontrolled sector tend to increase at a faster rate than before (Campbell, 56). Resources tend to follow prices thereby supplies in the uncontrolled sector will rise at the expense of the controlled sector. Therefore, controlling prices in one sector will eventually lead to price controls across the entire economy. This is what happened in the United States of America during the 2nd World war (Newberry, 201). One of the objectives of the government while implementing price controls is the concept of “fair prices”. The free market works well in a situation where many well-informed consumers are buying from multiple sellers who can develop a reputation for high or low quality (Breyer, 99). The market prices are fair between buyers and innovators. However, there are situations where there could be inadequate information between the parties and entrants may be discouraged. In kind of situations, government may impose price controls in an effort to protect citizens from exploitations (Breyer, 34). Creating the appearance of fairness that most prices are held constant, but efficiency is directly related to making frequent changes. Changes in the relative prices, exposes the bureaucracy administering price controls to frequent lobbying and complaints of unfairness. This conflict arose sharply after the American experience in the 2nd world war (Campbell, 177). When the controls fail and are removed, any prices that never reacted well at times of inflation will rapidly rise. This might cause further economic problems (Breyer, 192). Conclusion Price controls are an ineffective public policy. Artificially increased prices, such as those forced on goods covered by the government, not only reprimand buyers but end up throbbing the more efficient and successful producers (Wise, 115). If prices become too low, the result is low production of goods and services, reduced investments, and a decline in innovation. These adverse effects will cause losses to the entire economy and reprimand consumers in the long run. The government should let prices freely play their part in the economy, and opt for other policies that will assist them attain their set goals. By imposing price controls on a well-established, competitive market harms an economy by reducing trade and encouraging incentives to misuse resources. Indeed, price controls reduce quality, create rooms for black markets, and motivate costly rationing (Rockoff, 18). Although the policymakers are aware that price controls can be a dangerous practice, they continue to have strong incentives to legislate low prices for themselves. This can result to recommendations and implementations of sophisticated price controls. The best case for price controls is weak. The danger might be that according to Campbell (56): “the painkiller might be taken for the cure.” In the public’s opinion, price controls can be regarded as the way to free the monetary authority from the responsibility for inflation. Consequently, the pressures on the monetary authority to elude may result to a continuation or excess money supply growth. In order to be updated about free market competition, then a study of price controls become important (Schuettinger et al. 21). Through evaluation of cases whereby price controls have limited a proper work by price mechanism, an individual will gain a better appreciation of its usual efficiency and elegance. However, it is wrong to conclude that temporary price controls by the government may not be effective. But a fair view of economic theories and history shows just how these circumstances may be rare in this contemporary economy. Works cited Age?nor, Pierre-Richard, and Carlos M. Asilis. Price Controls and Electoral Cycles. Washington, D.C.?: International Monetary Fund, 1993. Print. Breyer, Stephen G. Regulation and Its Reform. Cambridge, Mass: Harvard University Press, 1982. Internet resource. Campbell, Colin D. Wage-price Controls in World War Ii, United States and Germany: Reports by Persons Who Observed and Participated in the Programs. Washington: American Enterprise Institute for Public Policy Research, 1971. Print. Marke, Julius J. A Catalogue of the Law Collection at New York University: With Selected Annotations. Union, N.J: Lawbook Exchange, 1999. Print. Nathanson, Nathaniel L, and Harold Leventhal. Problems in Price Control: Legal Phases. Washington, D. C: Office of Temporary Controls, Office of Price Administration, 1947. Print. Newberry, Lawrence S. Techniques, Policies, and Problems of Wage and Price Controls: A Comparison of Two Experiences in the United States. Ithaca, N. Y., 1974. Print. Rockoff, Hugh. Drastic Measures: A History of Wage and Price Controls in the United States. Cambridge: Cambridge University Press, 2002. Print. Schuettinger, Robert L, Eamonn F. Butler, and David I. Meiselman. Forty Centuries of Wage and Price Controls: How Not to Fight Inflation. Thornwood/N.Y: Caroline House, distrib, 1979. Print. Taylor, John B. Economics. Boston, Mass: Houghton Mifflin, 2008. Print. Wise, H L. Problems of Price Control. Christchurch: Whitcombe & Tombs Ltd, 1943. Print. Read More