Why price controls likely make things worse, not better

Phil Lewis wrote a good article on The Conversation today, about price controls:

Australian shoppers are facing a crisis in the fresh-food aisles.

Iceberg lettuces that cost $2.80 a year ago have doubled, or tripled, in price. Brussel sprouts that cost $4 to $6 a kilogram are now $7 to $14. Beans that cost $5 to $6 a kilogram are now more than double – and five times as much in remote areas...

The price hikes have led to calls for supermarkets to impose price caps to ensure shoppers can still afford to feed their families healthy food.

But price ceilings on goods or services rarely, if ever, work. Prices play an important role in allocating resources efficiently. They send a signal to both customers and suppliers. To arbitrarily reduce prices would only increase shortages – both now and in the longer term...

Higher prices provide a signal both to consumers and producers. They tell consumers to buy less and switch to alternatives. They provide an incentive for producers to grow more – though this process is fairly slow given the time needed to grow and harvest fruit and vegetables.

But eventually, if the market is left to its own devices, prices will eventually return to “normal”, consistent with historical prices.

Capping the price, on the other hand, will benefit those lucky enough to grab supplies when they available. But it will likely reduce supply even further, by affecting the decision of producers unwilling to supply at below-market prices.

It could also lead to a “black market”, with some customers sourcing supplies by other means at higher uncapped prices...

So generally price caps are to be avoided.

Now, if anything, Lewis understates the case against price controls (specifically, price ceilings - a legal maximum price which the market price is not allowed to exceed). Price ceilings are effective in lowering the price, but with a lower price, consumers want to buy more (this is the 'Law of Demand'). However, there isn't more to go around (if anything, the lower price reduces the incentive for sellers to supply the good. So, you have more consumers wanted to buy a restricted quantity of the good - it creates a shortage.

Shortages mean that the limited quantity available must be rationed in some way among the many consumers who want to buy at the low price. Usually, price is the main rationing mechanism in the market (only consumers who are willing and able to pay the market price will buy the good). However, when there is a price ceiling keeping the price artificially low, then some form of non-price rationing, is going to have to occur. Perhaps this rationing is based on who can get to the store first in the morning when the new stock is available, or is lucky enough to be at the store when shelves are re-stocked. Perhaps consumers have to queue in order to avoid missing out. Perhaps retailers have a lottery. Perhaps there is a rationing system where consumers are limited in the quantity they are allowed to buy. Perhaps interested consumers sign up and receive tickets that guarantee them a small amount of the good.

Notice how all of these non-price rationing alternatives do one of two things: (1) they impose a direct (non-monetary) cost on consumers (such as the time cost of queueing); or (2) they involve an element of luck. Higher non-monetary costs simply undo a lot of the good that the price ceiling was intended to create. Getting a good that you want only because you were lucky in a lottery, or happened to be in-store when shelves were re-stocked, is in my view not a particularly fair allocation system.

These non-price rationing schemes are also open to abuse, by consumers who are lucky (or who are happy to face the non-monetary cost) on-selling the goods to other consumers who are willing to pay more. This is the black market that Lewis refers to. And higher black market prices than the controlled price provide an incentive for unscrupulous sellers to ensure that their friends receive the goods in the lottery, or just happen to be in store at the right time. This sort of corruption is simply not worthwhile if there is no price ceiling in place.

For some graphic examples of how price ceilings can go wrong, look no further than rent controls (see some of my posts on that here, here, here, and here). The short version is that rent controls reduce economic welfare, they reduce the quality of housing available to rent, and they may even increase inequality. And, their effects get worse over time. In a famous quote, the Swedish economist Assar Lindbeck (who passed away in 2020) wrote that “Rent control appears to be the most efficient technique presently known to destroy a city - except for bombing.”

So, even though some consumers will certainly benefit from the lower prices that price controls create, we must never lose sight of the fact that they don't come with significant negative consequences as well.