The bad economics of price controls

 Why is the country experiencing rice shortages?

Demand and supply economic analysis provides answers to this question and valuable insight on how markets allocate resources. It is also enlightening to see what happens when the government uses the political process to fix prices and interfere with markets. Sometimes, either buyers or sellers with special interests will seek to gain by getting the government to impose price controls. Price controls may either be price ceilings, which set a maximum legal price for a product, or price floors, which impose a minimum legal price. Imposing price controls may look like an easy way for government to help buyers at the expense of sellers (or vice versa). However, price controls generate secondary effects that reduce the gains from trade and often harm the intended beneficiaries.

Let’s take a closer look at both price ceilings and price floors.

A price ceiling establishes a maximum price that can be charged for a good, service, or resource. If the price ceiling is set below the natural market equilibrium, a shortage will emerge. Producers are unwilling to supply as many units of the good as consumers would like to purchase at below the equilibrium fixed price. In addition, at the low fixed price, the quantity of the good exchanged declines, and the gains from trade of the buyers and sellers are reduced.

If it were not for the price ceiling, the price would rise, providing producers with a greater incentive to supply the item and consumers with more incentive to reduce their consumption. These natural forces would eliminate the occurrence of the shortage. But, the price ceiling keeps this from happening, and, therefore, other means must be used to allocate the smaller quantity among consumers wanting to purchase.

Predictably, non-price factors will become more important in the rationing process. Waiting lines will sometimes develop, allocating the item to those most willing to wait in line. Sellers will tend to favor their friends or those willing to provide them with favors or illegal under-the-table payments. Quality deterioration will also play a greater role. It is important to note that there are two ways that sellers can raise prices. First, they can raise their money price, holding quality constant. Or, second, they can hold the money price constant while reducing the quality of the item. (The latter might also include reducing its size.) While the price ceiling eliminates increases in money prices, reductions in quality provide an alternative path for price increases. Clearly, it is more difficult to repeal market forces than it initially appears.

The current government policy on rice price controls provides a real world example of a price ceiling. The expected results—shortages, deterioration in quality with the appearance of rice weevils or “bukbok,” favoritism, corruption, and black market side payments are all observable in this situation.

A price floor establishes a minimum price that can be legally charged. When a price floor is imposed above the current market equilibrium, it will alter the operation of markets. At the higher price, the quantity supplied increases while the quantity demanded decreases. A surplus will result at the controlled price. Like price ceilings, price floors also reduce the quantity of the goods exchanged and the gains from trade.

As is the case with price ceilings, non-price factors will play a larger role in the rationing process. But because there is a surplus rather than a shortage, buyers this time will be in a position to be more selective. Buyers will purchase from sellers willing to offer them non-price favors—better service, discounts on other products, or easier credit terms, for example. When it’s difficult to alter the product’s quality—in this case, improve it to make it more attractive for the price that must be charged—some producers will be unable to sell it.

When price floors are imposed in the real world, surpluses and increased importance of non-price factors are observable. Minimum wages provide an example of a price floor. The minimum pushes the wages of various categories of inexperienced, low-skilled workers (such as the youth) above the equilibrium. In this case, the surplus takes the form of high unemployment rates and few training opportunities for workers in these categories. While some low-wage workers are helped, others are thrust into unemployment and their opportunity to acquire training and experience are severely restricted.

Clearly, when analyzing price controls, it is important to consider the secondary effects. Remember, even if the intentions are good, this will not guarantee a desired outcome.

Because of the bad economics of price controls, I support the stand of the Foundation of Economic Foundation and the call of Senator Cynthia Villar, chairperson of the Senate Agricultural Committee, and Senator Sherwin Gatchalian for the abolition of the National Food Authority:

“The NFA has only caused and aggravated the rice inflation and rice shortage in several regions, compounded the debt and losses of the national government, and provided opportunities for graft and corruption for its officers and employees, from the purchase of imported rice to the distribution and transportation of subsidized rice.”

“With high average rice prices and periodic shortages, the NFA has also contributed to the country’s high wage costs and lower competitiveness.”

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Topics: Economic , National Food Authority , Price , Senate Agricultural Committee , Cynthia Villar , Sherwin Gatchalian
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