Price controls are said to exist whenever government mandates a maximum price (“price ceiling”) above which a good or service cannot legally be sold or a minimum price (“price floor”) below which a good or service cannot legally be sold.
Price ceilings attempt to lower the cost to the consumer of acquiring the price-ceilinged product, whereas a price floor attempts to increase the return received by sellers of the product in question. Both schemes achieve outcomes opposite of their objectives.
In markets without price controls, prices are determined by the interaction of the voluntary purchase and use decisions of buyers (“demand”) with the voluntary production and sales decisions of sellers (“supply”). If, for whatever reason, buyers demand a product more intensely than had previously been the case—meaning that, at a specific price, they are prepared to buy greater quantities of it today than they were willing to buy yesterday—the result will be that the price will go up.
Although the precise process through which this higher price is achieved varies from market to market, the result is unambiguously desirable. If consumers want to use a product more intensely than before, it is appropriate that the economy produce more of it. Because increased production of a product requires that resources be drawn away from other productive enterprises, the cost per unit of producing any product will generally rise as that product is produced at a higher rate of output. In short, producers will increase the quantity they supply only if they can fetch a higher price for it.
This constraint also holds true for changes in supply. For example, if a hurricane inflicts unexpected damage to oil rigs and refineries, the price of gasoline will rise to reflect its now-greater scarcity. Thus, market prices reflect a multitude of deeper market conditions—conditions summarized by the terms demand and supply. They also prompt buyers and sellers to act in ways consistent with these underlying conditions. If the demand for apples increases, the resulting higher price for apples reflects this reality and prompts producers to supply more apples.
Price controls generate a distorted report of reality, causing buyers and suppliers to act in ways inconsistent with it. Suppose the market price of apples were $4 per pound if not for a government-enforced price ceiling of $3 per pound. This price ceiling misinforms consumers about the relative scarcity of apples, signaling them that apples are more abundant than they really are. The result is that consumers attempt to consume apples at too great a rate. This problem is compounded by the fact that the same price ceiling leads producers to ignore the real, higher value of apples and instead act as if consumers valued apples at only $3 per pound, thus supplying fewer apples than they would were the price $1 higher. The consequence is an apple shortage.
By itself, a shortage is bad enough. But shortages always are accompanied by subtler, less visible problems. One such problem is the extra expenditure of time and other nonmonetary resources on efforts to acquire the product. For example, when lines form, people spend extra time attempting to purchase a product in short supply. What determines how much of these nonmonetary resources consumers spend in such efforts?
The answer is the product’s market value. The higher the market value, the greater is the value of time and other nonmonetary resources that consumers will spend attempting to acquire the product. Because a price ceiling causes suppliers to bring to market fewer units of the product than otherwise—making the product scarcer—the market value of the product rises above the value that would prevail without price controls. Consequently, a price ceiling increases the value of total resources (money plus nonmonetary resources) that are spent on the price-ceilinged product. The cost of the product rises, rather than falls.
One particular nonmonetary resource warrants specific mention. Those people with political and commercial connections are better able to acquire the price-ceilinged good through nonmarket means. The effect is to allocate such products in a more arbitrary manner than would be the case if government had not attempted to regulate prices.
A similar economic analysis applies to the consequences of price floors. By arbitrarily raising the price of a good or service above its market level, a price floor creates a surplus (a willingness of suppliers to supply greater quantities than consumers are willing to buy). Also like price ceilings, price floors reduce the quantities of the product that consumers actually acquire. Price ceilings do so by reducing the quantities supplied, whereas price floors do so by reducing the quantities consumers buy. This condition also creates advantages for certain parties. When a product is in surplus and its price is prevented from falling, sellers who have special connections with buyers are better able to sell their products than are sellers who enjoy no such advantages.
A final similarity worth mentioning is that, just as price ceilings cause the market value of products to be higher than otherwise, price floors cause the market value of products to be lower than otherwise (although the aim is to raise this value). By enticing suppliers to bring more to market than they would bring at the lower (uncontrolled) price, the market is flooded with more units of the product than consumers wish to buy—and more units than would be supplied at the uncontrolled price.
Market prices are not arbitrary figures. They reflect a deep and complex underlying reality. This reality—whether good or bad, improving or deteriorating—is best dealt with when it is revealed as accurately as possible. Price controls distort consumers’ and producers’ views of reality, leading them to act in harmful ways.
Becker, Gary. Economic Theory. Piscataway, NJ: Aldine Transaction, 2007.
Friedman, Milton; with Friedrich Hayek, George J. Stigler, Bertrand de Jouvenel, F. W. Paish, F. G. Pennance, E. O. Olsen, Sven, Rydenfelt, and M. Walker. Rent Control: A Popular Paradox. Montreal: Fraser Institute, 1975.
Friedman, Milton, and Steven Medema. Price Theory. Piscataway, NJ: Aldine Transaction, 2007.
Originally published .