The Danger of Price Control

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Price control is something that may sound like great idea on the surface. Why not set prices on essential products and services (gas, food, electricity, etc.) at a level that is “affordable” to the average consumer? As with many naive ideas, there come some fundamental problems. And this idea is no different.

In a free market, prices are determined by the market activities (the functioning components of the market activities are price, supply and demand). In the basic idea of supply and demand, companies try to set the price of a particular product that they are selling at an amount that will cause consumers to buy the product at the same rate of production. If the price of the product is set too high (a price higher than the consumer is willing to part way with their money acquire the product), then fewer consumers will buy the product, leaving a surplus of products not sold. If the price is set too low, then more consumers will be willing to buy the product than is able to be supplied, and thus causing a shortage.

Companies selling products are always trying to set the price on their product at an amount where supply and demand are equal. In other words, companies want to produce the exact amount of products that consumers will buy, no more, no less. That makes sense, doesn’t it? But we know, in reality that hardly ever happens. In theory, if a company could know at exactly what price to sell their product in order to attract consumers to buy the exact amount of their product that they produced (supplied), then there would be no need for companies to have any overstock or any other surplus goods held in inventory. This is the concept of supply and demand equilibrium. Embedded into the price that is being considered is the amount of profit that the producer of the product will make for each item sold.





Now, when one of the functioning components of the market, by law and legislation, are not able to operate freely (meaning, freely able to be affected by market activities), the other components will be affected. Again, the three fundamental components or factors are price, supply and demand. And when you affect one third of the equation, things will change drastically…and change quickly. When supply is artificially constrained (i.e. government legislation demands that only a certain amount of a particular good can be available to the market), then price is affected (artificially made to increase). For example, when the countries that we import oil from (to produce gasoline) put caps on the amount of oil they will supply to the world, the price of that oil will increase, assuming no change in demand for that oil. That makes sense, right? Because there are a lot of companies in the world that want and need that oil to produce the gasoline to satisfy their particular set of consumers that desire to fill their vehicles up with gasoline (and in this example, the supply of that oil is limited). These companies are willing to pay more for that oil because there are other companies trying to buy the same, limited amount that is being supplied. But, they can only pay an increased amount up at a certain point. They cannot pay just any amount. They can only pay an amount up to the point that it ceases to become cost-effective.

That brings us to another side of the coin. When governments artificially constrain prices, we get a similar affect. When prices, by law and legislation, are fixed at a certain amount, the product being sold does not magically become cheaper to produce. No, in fact, it will at the very least be more expensive to produce. And maybe the product will become even impossible to produce in the long run, because the amount of money that is required to produce the good (labor, materials, etc.) may exceed the amount that the company is allowed, by law and legislation, to charge a consumer to buy (price). At that point in time, there is no reason or incentive for the company to continue to produce a product that they will only lose money on. And eventually, if nothing changes in terms of the control on the price, the product will become unavailable because companies will have no reason (or incentive), by means of a profit, to produce it.

We see this phenomenon in many facets of life, when governments have tried to control the price of a good or service in the private sector of business, only to see either the quality dwindle or the quantity disappear. We see it in rent controlled housing, where the quality of the housing deteriorates. Again, if the landlord can only charge a certain amount of rent, by law or legislation, it limits the amount of resources he can spend to maintain the property, given all of the other operating expenses involved in leasing the apartments (wages to property manager, property taxes, etc). We have also seen the effects of price control in the medical industry, where governments have capped the price on certain medicines, only to make the medicine eventually unavailable because the manufacturers cannot afford to produce the medicine at the controlled price, and still make a profit.

As we look at the idea of price control, we see that there are many unintended consequences. More specifically, we eventually see the complete opposite effect of the intended outcome. While the outcome of price control is to provide goods and services to consumers that would otherwise not be able to afford them, if the price is allowed to be controlled for too long, those very goods will eventually be unavailable altogether because they would cease being produced.

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