# Price Controls

## The Vision of Interventionism

In Part II of this book, we explained the basic structure and functioning of a pure market economy. In Part III, we surveyed the theoretical problems with pure socialism, and documented some of the horrors of socialist systems in practice.

In this final portion of the book, we will examine some of the most popular components of interventionism, which is an approach to economic policy that seeks to avoid the alleged flaws of pure capitalism and pure socialism. An interventionist government will not tolerate the outcomes of a purely free market, but on the other hand it doesn’t completely abolish private property. The goal of interventionist policies is to retain the obvious advantages of a free enterprise system, while at the same time moderating the “excesses” of pure capitalism through various corrective measures.

The following lessons will demonstrate that government intervention into the market economy leads to unintended consequences, which very often make the “cure” worse than the disease, even according to the official goals of the interventions. You may be surprised to learn that many of the problems with modern society are either exacerbated or even caused by government intervention. The example of this lesson is price controls, in which the government enforces a different price from the market-clearing equilibrium price. We break the discussion up into the treatment of price ceilings and price floors.

## Price Ceilings

A price ceiling is a legal maximum the government sets on prices in the marketplace for a particular good or service; the idea is that a rising price hits the “ceiling” and is not legally allowed to go any higher. Typically the official rationale for a general price ceiling is that it keeps important items affordable for the poor; a classic example would be rent control, in which the government imposes caps on rental rates for certain types of apartments. In specific situations, temporary price ceilings may be imposed to prevent “gouging” of the public in times of distress. For example, after a natural disaster strikes, the local or state government might impose price controls on items such as bottled water, electric generators, and gasoline, in an effort to prevent merchants from “taking advantage of” the situation.

Although the general public applaud such restrictions—if they weren’t popular, they wouldn’t be so prevalent—our knowledge of how markets work will show that price ceilings actually hurt the very people they are supposed to be helping. The following list isn’t exhaustive, but it mentions some of the most damaging consequences of price ceilings:

### Immediate Shortages

If it is to have any impact, a price ceiling must be set below the market price. But under normal circumstances, the actual market price will tend to be close to the market-clearing price, which (we recall from Lesson 11) is the price at which the quantity supplied equals the quantity demanded. Now if the government forces the price lower by imposing a price ceiling, it will cause a shortage of the good or service in question. The following diagram illustrates:

Market for Apartment Units

In the diagram above, the original price of $800 is the equilibrium price to rent an apartment in an urban neighborhood. At that price, consumers want to rent a total of 10,000 apartment units, and owners want to rent out 10,000 apartment units. The market clears and everyone engages in as many transactions as he wants, subject to the high price. But then the government imposes a price ceiling at$650, claiming that “regular people can’t afford” to pay higher rents, and threatening to heavily fine any landlord caught charging more than this amount. At the lower price, the quantity of apartment units demanded rises to 12,000, while the quantity supplied drops to 9,000.[8] There is now a shortage of 3,000 units, meaning that 3,000 people in the neighborhood want to rent an apartment at the going price, but can’t find any available units.

Shortages are quite serious because they make the good or service unavailable for the very people supposedly helped by the price control. It’s true, the 9,000 people who still have an apartment might be thankful that they are saving $150 per month on their rent (though perhaps not if they understand all of the additional points below). However, there are now 1,000 people in the community who would have had an apartment with market pricing but now have no apartment at all because of the price ceiling. We know that they would prefer to pay$800 for an apartment rather than having none at all (since the quantity demanded would be 10,000 total at a price of $800), and so they are clearly worse off because of the rent control.[9] At this first step in the analysis, therefore, we must balance the gains to the 9,000 renters (who save$150 a month) against the presumably much more traumatic loss to the 1,000 renters who have an extra $800 a month, but not an apartment of their own. Even if we completely ignore the fate of the landlords—who are clearly worse off because of the rent control—and focus exclusively on helping tenants, it is not clear that the price ceiling has actually made the group as a whole better off. The tradeoff is even more striking in other situations of price ceilings. For example, suppose a hurricane strikes a city, knocking out the power and causing flooding that contaminates the drinking water. Left to their own devices, the market prices of bottled water and canned goods would have a tendency to skyrocket because of the sharp increase in demand versus the fixed supply. If the local government passes an ordinance fining merchants who raise their prices on “necessities” in response to the emergency, that won’t result in everyone (including the poor) getting access to the items. On the contrary, what will happen is that the first few people to get to the store will clear out the shelves, loading up on bottled water and canned food at the pre-crisis prices. People who get to the store a few hours later will walk away with no water or food at all. For such poor souls, the officially reasonable prices are small consolation. They would much rather have paid$5 each for 10 bottles of water, than to have their family drink Coke for a week.

## Price Floors

A price floor is a legal minimum, in which the government does not allow the price of a good or service to fall below the “floor.” Buyers caught paying less than the floor price face fines or other forms of punishment. The public justification for price floors is that certain sellers deserve a higher price for their goods or services than what they would receive in a pure market economy.

In modern Western countries labor is the primary recipient of price floors.[10] In particular the government imposes a minimum wage making it illegal for an employer to pay a worker less than a certain amount per hour. Because this is the most popular and recognizable example of a price floor, we will concentrate on it for the rest of this lesson.[11] The analysis generally applies to other goods or services.

As with price ceilings, price floors have many unintended consequences, which should make the proponents of the minimum wage reconsider whether they are really helping unskilled workers. The consequences include:

### Immediate Surplus (or Glut)

The market-clearing price (wage) for unskilled labor equates the quantity demanded by employers, with the quantity supplied by unskilled workers. If the government sets a floor above the market-clearing level, then it will induce a surplus of unskilled labor. There will be a supply glut, meaning more workers are trying to find jobs at the going wage than employers want to hire. This situation is more popularly known as unemployment. The following diagram illustrates the effects of a minimum wage law.

Market for Low-Skill Labor Services