You're applying for a dream job at a particular organization. You “just know” that this occupation is right for you – or, at least, that it will lead you to a great career. But then you are told that the position doesn't actually pay you. You have to work for free if you work there, and you won't get compensated with anything else, either. Are you likely to stick around by working for this organization? If you're particularly altruistic, you might stick around just for the rewarding feeling of “helping people.” But most people would quickly abandon the job, and move to something that actually pays – particularly when they've got kids or other obligations to take care of.
As the price of a product goes up, the market is willing to supply more of it (go figure) …
If this was your reaction, then you probably understand that there's a correlation between price and quantity supplied. That is to say, you're willing to supply more of a particular kind of labor at a higher price than at a lower price. Other things being equal, most people would be more willing to work at a higher-paying job than at a lower-paying job – again, other things being equal. Common sense, right? But workers aren't the only ones who think this way – the managers of private-sector companies also think much the same way. They're willing to supply more of their product at a higher price than at a lower price. Many of them would abandon their industry, if forced to work for free (perhaps even most of them). Some of them would even abandon their industry if they could still make some money, but just not as much of it as before. Chances are that they would go to another industry where they could make more profits. This is great for these other industries, but not so great for the industry that's being abandoned like a sinking ship. If you want particular industries to produce well, the prospects of rewards have to be good enough to make it worth their while to fulfill people's needs for that kind of product. If they aren't good enough, the industry will shrink – or, in some cases, even disappear (as sometimes happens, for example, with products that have become obsolete – a case where they should disappear).
Edison wax cylinder phonograph (circa 1899), an obsolete product that is no longer made
Necessities are not exempt from these laws of supply and demand …
Some advocates of price controls will respond by saying: “But some things are necessities – such as food, housing, and medicine. Some people just can't pay for these necessities,” they say. “Thus, we should set a maximum price for these things, so that they can't possibly be charged more than that for them.” The problem with this argument is that “necessities” are not exempt from the universal laws of supply and demand. The same supply laws that apply to other products also apply to necessities as well. As you lower the price of any product, you will also lower the quantity of this product that the market is willing to supply – thus making it harder and harder to get this product. Some might argue that the market will actually demand more of that product when the price is lower, thus “incentivizing” people to supply more of it. It is true that demand increases as prices go down, but that does not always translate into what Adam Smith called an “effectual demand” – that is to say, a demand accompanied by enough reward to actually incentivize the production of the product at sufficient levels. If the price of your labor was cut in half (or even eliminated entirely), there would indeed be plenty of demand for your labor at that price; but would you actually be willing to supply it under these conditions? Most people would probably cut back on the amount that they're willing to supply of that kind of labor. In some cases, they might even leave the occupation entirely, and instead supply some other kind of labor to the market. Private-sector companies work much the same way, and are willing to supply much higher quantities of their product when the price is higher. Demand is obviously relevant, but so is supply; and we cannot ignore either factor.
Poster for price controls during World War II
Price controls never improve things, but can often create shortages (with long lines and waitlists)
But what about those cases where companies are charging above the market price for a product? To answer this question, we must first define what we mean by a “market price.” In economic terms, a “market price” is just an equilibrium price – that is to say, a price where the supply and demand are in balance. It would indeed be possible for them to charge above this price if they wanted to, but they would be swiftly punished in a free market for so doing. As they increase their price, the demand for their product goes down. If there are long lines and waitlists for a product, then it would actually make some sense for them to do this – not only because they get more profits for themselves, but also because it has the beneficial economic effect of shortening the lines and waitlists for these products. People don't have to wait as long to get this product under these conditions, and they can thus actually get it with higher frequency (especially when they need it). But if their price becomes so high that few (if any) are willing to pay it, the company will be punished with lower sales, lower revenues, and (by extension) lower profits. What self-interested company would ever want to do this? They would have plenty of incentives not to do so, which would work far more effectively (and far more quickly) than any government “price controls” ever could. If their product is really above the market price (as some say it may be), then no price control is actually needed to get them to reduce it. If their product is at the market price, then no government intervention is needed here, either, because one is already at the ideal outcome under these conditions. But if their price is lower than the market price, then the market won't supply as much, and the availability of that product will thus dwindle. Maximum prices can never improve things beyond what they already are, but can only hinder things by reducing their supplies and creating painful shortages. In other words, they cannot help, but can only hurt.
Long line for cooking oil – Soviet-controlled Romania, 1986
Handouts are a better way of helping our poorer citizens than “price controls”
So how should we help our poorest citizens, then, who cannot afford to pay the market prices (whatever they are)? In other words, what do we do, when they are unable to afford even the most basic of “necessities”? Maximum prices will not work for this, but handouts will (at least to a certain degree). Handouts provide these services without shrinking the industries that provide them – which is the unavoidable consequence of “maximum prices.” Handouts are not without their drawbacks, as it turns out, but they work far better than price controls ever have. Price controls just don't work, period, and have enormous potential to backfire on us by making the controlled product significantly harder to obtain. In the 1970's, President Richard Nixon tried to fight inflation by imposing a “moratorium on prices,” which would freeze wages and prices at their current levels. But as critics of price controls would have predicted, it didn't work; and for at least some products (whose prices were now below equilibrium), they led to shortages, long lines, and waitlists. Once the price controls were removed, the markets were filled with goods; and people were actually able to obtain these affected products (and the other products) when they needed them. Price controls have never worked even once, but they have failed numerous times throughout their history. All the good intentions in the world can't cause price controls to work, and there is no direction to go but downwards when you implement a price control.
President Richard Nixon
If something is indeed a “necessity,” all the more reason to have free markets to produce it …
Incidentally, critics of free markets are sometimes inclined to set a minimum price as well – most prominently, a minimum wage. If this is a topic that you're interested in, I invite you to view another of my posts, which talks about the disadvantages of “minimum wage” policies. But suffice it to say in this post that neither kind of price control works, and that there is no direction to go but downwards for both of them. With minimum wages, they often lead to reduced work hours, lower availability of employment, and (in some cases) outright unemployment – harming the very people that it is intended to help. For further development of these arguments, see this other blog post of mine. In this post, suffice it to say that any kind of price control is a mistake, and that neither policy has any potential to actually help the poor. The one policy makes their work hours harder to obtain, and the other creates shortages of the products that they so desperately need and want. Laws against “price gouging” or “profiteering” might seem at first like the most “consumer-friendly” of policies; but in reality, they often reduce the supply of these needed products, and make them unavailable – or, at least, very difficult to obtain. If these products are indeed “necessities” (as we are so often told they are), then that's all the more reason to have free markets that will actually produce them in high quantities. If the supply exceeds the demand, then goods will sit on the shelf not being sold (the drawback of a “surplus”). And if the demand exceeds the supply, then that is the very definition of a “shortage” – with long lines and waitlists as a necessary consequence. The only system that actually works in practice is the free market, which achieves true balance in supply and demand, allowing us to get these products far more often – especially when we need them. And if we want to help our poorest citizens, we need a free market that can actually produce things to be re-allocated to them via handouts.
If you liked this post, you might also like:
The minimum wage doesn't really help the poor …
Why do patent-holders have “monopolies” on the production of their product?
How the laws of supply and demand work
My love-hate relationship with economics
Some thoughts about economics education
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