You can't repeal the Laws of Supply and Demand
Supplies and demands shift constantly, so we might expect relative prices to bounce around like ping-pong balls. We all want low prices for things we buy and high prices for things we sell. Some people gain while others lose when prices change, but lone individuals influence market forces very little. Special-interest groups, however, often persuade government to set price controls.
Price ceilings officially reflect attempts to curb inflation, control monopoly power, or to help the poor by holding down prices for "essentials." Unfortunately, ceilings are seldom appropriate tools for any of these tasks.
A price ceiling is a maximum legal price.
A price ceiling set above the equilibrium market-clearing price is usually as irrelevant as a law limiting joggers to 65 miles per hour. But price ceilings below equilibrium create shortages and drive up opportunity costs–only the legal monetary price is kept from rising. Shortages waste resources because less efficient mechanisms prevail when prices cannot adjust. Price ceilings induced shortages of thousands of items (e.g., gasoline, auto parts, and some types of food and clothing) during World Wars I and II. Widespread shortages also followed President Nixon's 1971 wage/price freeze, which was phased out and then largely abandoned by 1976.
Suppose a price ceiling of $1 per gallon were imposed in the gasoline market shown in Figure 6. The quantity of fuel demanded daily will be 75 million gallons, with quantity supplied being only 30 million gallons. An excess demand (or shortage) of 45 million gallons exists. Who will get gasoline? People who bribe service station attendants, those who persuade government to give them priority access, or those who wait through long lines. Even people who waited 2 to 4 hours in gasoline lines in 1974 and 1975 often went without because the pumps ran dry. Note that, unlike a higher price, these long lines generated no corresponding benefits for suppliers, so time spent queuing is a "dead-weight" loss–if prices had been allowed to rise, suppliers would have had more incentives to produce.
Figure 6 Governmentally Induced Shortages in the Gasoline Market
This figure shows the effect of a $1-per-gallon ceiling on the price of gasoline. At $1 per gallon, 75 million gallons will be demanded but only 30 million will be supplied. This creates shortages and stimulates non-price allocation methods: Queuing, black market deals, and so on.
Price controls maintained for long periods are especially inefficient. They (a) necessitate an enforcement bureaucracy that will tend to grow over time, (b) stimulate costly lobbying for "exceptions" that allow some prices to rise, and (c) create immense pressures for corruption of the officials in charge of enforcement
But ceilings keep average prices down, don't they? Sorry, but NO! The people who most value the 30 million gallons of gas available daily tend to get it. They are willing to pay at least $2 per gallon for gasoline; that is, an extra dollar per gallon in waiting time, lobbying, or as a black market premium.
A black market is an illegal market where price controls are ignored.
Had the price ceiling not been imposed, the price of a gallon of gasoline would have been roughly $1.25. Although the legal monetary price of gas is held at $1 per gallon by this ceiling, its opportunity cost rises to $2 to typical customers.
The costs of queuing, however, tend to be lower for the impoverished or jobless. Poor people may gain from ceilings because waiting in line secures gas that they might lack funds to buy if its monetary price rose. Some people view such redistributions as worth the inefficiency price controls create. Nevertheless, price ceilings create shortages so that opportunity costs–including money, time wasted in lines, and illegal side payments–unnecessarily exceed free-market prices. Only pump prices are controlled; real costs to average consumers are not. This situation was exemplified perfectly in former Communist Russia where the poor of their society spent hours every day waiting in lines if they wanted to get bread, clothing, or any other good. Many times those who didn’t arrive before the sun came up to wait in line would be sent home empty handed, the day’s quota of goods having run out. Meanwhile, those with better means (and for whom the opportunity cost of waiting in a line outweighed the benefits of a cheaper price for a good) went to one of the many black markets which flourished within the Soviet Union and bought what they needed there.
Price controls of a different type are aimed primarily at redistributing incomes.
A price floor is a minimum legal price.
Price floors set below equilibrium tend to be as irrelevant as laws requiring pilots to fly above sea level, but floors exceeding equilibrium create artificial surpluses and raise costs. Price floors are most common in labor markets (minimum wage laws) and agriculture, where government attempts to boost farm incomes by maintaining farm commodity prices above equilibrium. Figure 7 depicts the consequence of price floors in the cotton market.
Figure 7 Surpluses in the Cotton Market
Price floors generate surpluses, as this figure illustrates. If the government maintains the price of cotton at $0.75 per pound, quantity supplied exceeds that demanded by 2 million bales. The surplus ends up in the hands of the government, which must buy the surplus to maintain the price at $0.75. Thus, taxpayers pay $0.75 per pound for cotton for which they then pay storage costs. Furthermore, the cost to society of producing the 5-millionth bale far exceeds its value. Thus, such policies tend to waste scarce resources.
Equilibrium occurs at 4 million bales annually at $0.60 per pound of cotton (point e). A floor at $0.75 per pound yields a quantity supplied of 5 million bales, but only 3 million bales are demanded–excess supply (surplus) is 2 million bales annually. Government can ensure the $0.75 price by buying and storing excess supplies. (Federal warehouses often hold mountains of surplus wheat, cotton, corn, beet sugar, peanuts, and soybeans.) Alternatively, the government can pay cotton farmers not to produce or limit the amount of planting. (It has done both.)
Inefficiency is a major problem. In our example, consumers view the 5-millionth bale as worth only $0.45 per pound, even though this last bale cost $0.75 per pound to grow and harvest. Worse than that, people do not get to use the surplus 2 million bales society (via government) buys from farmers. Hardly a bargain!
In summary, price ceilings cause shortages and do not hold down the real prices paid by most consumers. Shortages drive up transaction costs, so price ceilings actually raise the opportunity costs incurred in acquiring goods. Some desperate buyers must go without even after enduring long queues or extended shopping trips intended to acquire information and locate goods. On the other hand, price floors cause surpluses. Production costs of the surplus goods exceed their values to consumers.
If price controls tend to be counterproductive, why are they so common? In some cases, price ceilings are enacted because voters favor them, mistakenly perceiving controls as a solution for inflation. Most of the time, however, controls are political responses to pressures from special-interest groups. Some beneficiaries of controls are obvious: Price floors in agriculture survive because of bloc voting by generations of farmers. Other gainers are less obvious: Farm machinery manufacturers, for example.
Even price supports have not prevented persistent crises in agriculture, however, as evidenced by rampant farm foreclosures from 1981 to 1987. Technological advances allow ever decreasing numbers of farmers to feed our growing population. Price supports have merely slowed the painful flow of people from agriculture into other work.
Rent controls have been enforced for long periods in some cities, including New York City and Santa Monica, California. Long-term tenants are only one group that gains from rent controls. Current homeowners and homebuilders, for example, gain if apartment shortages cause potential renters to switch into buying rather than renting. Rent controls drive up prices for both new and existing housing. What if you’re lower to middle income and are new to the area? Securing affordable housing can be extremely difficult. Thus, losers from rent controls include landlords (whose income suffers) and potential renters who seek vacant apartments in vain.
Most direct gainers from controls are very conscious of their gains, but long-run losers from controls may not recognize their losses. For example, you might favor rent controls limiting the rent your current landlord sets. But will you blame controls if you decide to relocate and cannot find an apartment? Rent control tends to squelch apartment construction and turn older rental units into slums. Shortages of rentals and inadequate maintenance by landlords are predictable consequences of rent controls.
Special interest groups that lobby for controls tend to be among the "winners," but even their gains are eroded by lobbying costs and related inefficiencies. One lesson from price controls is that market forces often thwart policies that, on the surface, seem compatible with good intentions and intuition. Economic reasoning may be a better guide in designing efficient and humane policies for areas ranging from farming to rentals to minimum wage laws to illicit drugs. Minimum-wage laws, for example, may hurt far more workers than they help, with young workers and members of minorities being especially hard hit.