Price controls

Not to be confused with fixed price or price fixing.

Price controls are governmental restrictions on the prices that can be charged for goods and services in a market. The intent behind implementing such controls can stem from the desire to maintain affordability of staple foods and goods, to prevent price gouging during shortages, and to slow inflation, or, alternatively, to insure a minimum income for providers of certain goods or a minimum wage. There are two primary forms of price control, a price ceiling, the maximum price that can be charged, and a price floor, the minimum price that can be charged.

Historically, price controls have often been imposed as part of a larger incomes policy package also employing wage controls and other regulatory elements.

Although price controls are sometimes used by governments, economists usually agree that price controls don't accomplish what they are intended to do and are generally to be avoided.

Historical examples

WWI poster of the United States Food Administration

WWII poster about US price controls

The Roman Emperor Diocletian tried to set maximum prices for all commodities in the end of the 3rd century AD, but with little success.

Governments in planned economies typically control prices on most or all goods, though these schemes have not sustained high economic performance and have been almost entirely replaced by mixed economies.

Price controls have also been used in modern times in mostly free-market economies for such things as rent control.

During World War I, the United States Food Administration enforced price controls on food. Price controls were also imposed in the US and Nazi Germany during WWII.

Wage controls have been tried in many countries to reduce inflation, but this is seldom successful. Modern economic theory supports the alternative remedy of reducing the money supply, proposing that monetary inflation is caused by too much money creation by the central bank.

States have sometimes chosen to implement their own control policies. California controls the prices of electricity within the state, which economist Thomas Sowell blames for the occasional electricity shortages the state experiences. Sowell said of California's controls in 2001: "Since the utility companies have been paying more for electricity than they were allowed to charge their customers, they were operating in the red and the financial markets are downgrading their bonds." California's price-setting board has agreed to raise rates, but not as much as the companies were paying on the wholesale market for their electricity. Economist Lawrence Makovich contended, "We've already seen in California that price caps on retail rates increased demand and made the shortage worse and price caps also forced the largest utility, Pacific Gas and Electric, into bankruptcy in four months." While some charged that electricity providers had in past years charged above-market rates, in 2002 the San Francisco Chronicle reported that before the blackouts, many energy providers left the state because they could make a greater profit in other Western states. The Federal Energy Regulatory Commission stepped in and set price caps for each megawatt of power bought, after lifting the caps to avoid rolling blackouts six months previously.

The state of Hawaii briefly introduced a cap on the wholesale price of gasoline (the Gas Cap Law) in an effort to fight "price gouging" in that state in 2005. Because it was widely seen as too soft and ineffective, it was repealed shortly thereafter.

Criticisms

The primary criticism leveled against price controls is that by keeping prices artificially low, demand is increased to the point where supply can not keep up, leading to shortages in the price-controlled product. For example, Lactantius wrote that Diocletian "by various taxes he had made all things exceedingly expensive, attempted by a law to limit their prices. Then much blood [of merchants] was shed for trifles, men were afraid to offer anything for sale, and the scarcity became more excessive and grievous than ever. Until, in the end, the [price limit] law, after having proved destructive to many people, was from mere necessity abolished." As with Diocletian's Edict on Maximum Prices, shortages lead to black markets where prices for the same good exceed those of an uncontrolled market. Furthermore, once controls are removed, prices will immediately increase, which can temporarily shock the economic system.

A classic example of how price controls cause shortages was during the Arab oil embargo between October 19, 1973 and March 17, 1974. Long lines of cars and trucks quickly appeared at retail gas stations in the U.S. and some stations closed because of a shortage of fuel at the low price set by the U.S. Cost of Living Council. The fixed price was below what the market would otherwise bear and, as a result, the inventory disappeared. It made no difference whether prices were voluntarily or involuntarily posted below the market clearing price. Scarcity resulted in either case. Price controls fail to achieve their proximate aim, which is to reduce prices paid by retail consumers, but such controls do manage to reduce supply.

Nobel prize winner Milton Friedman said "We economists don't know much, but we do know how to create a shortage. If you want to create a shortage of tomatoes, for example, just pass a law that retailers can't sell tomatoes for more than two cents per pound. Instantly you'll have a tomato shortage. It's the same with oil or gas."

U.S. President Richard Nixon's Secretary of the Treasury, George Shultz, enacting Nixon's "New Economic Policy," lifted price controls that had begun in 1971 (part of the Nixon Shock). This lifting of price controls resulted in a rapid increase in prices. Price freezes were re-established five months later. Stagflation was eventually ended in the United States when the Federal Reserve under chairman Paul Volcker raised interest rates to unusually high levels. This successfully ended high inflation but caused a recession that ended in the early 1980s.

See also

• Administered prices
• Capital control
• Monopsony
• Incomes policy
• Rent regulation
• Council on Wage and Price Stability