Price Controls, Episode XXVIII: The Empire Strikes Back
The spike of inflation last year has brought a rebirth to a debate of long-forgotten times: Price controls are ‘en-vogue’ again. Higher prices at the gas station, higher electricity prices, and higher prices for natural gas → many, mostly left-leaning, politicians propose that governments intervene and implement price-ceilings to protect consumers from rising expenditures. Everywhere, price-controls are entering the discussion once again, as one can easily observe via google.
The idea is simple: Politicians consider prices for good A as too high and thus say that, by law, companies that produce good A are not allowed to sell it above a specific price (in the picture above, that’s the blue line). Mostly, they argue that it’s just greedy corporations who want to rip off people for profits, and hence, corporations could easily afford to sell A at lower prices.
Probably, in reality, it depends on the height of the price ceiling, as the General Equilibrium Model is a little bit oversimplified. If prices are set a little bit below the equilibrium level, companies may continue to produce the same amount of good A.
But even then, economic reality kicks in: As prices fall (by law), demand increases. That’s economics 101.
Without government interference, if demand>supply, companies will either raise prices or, if possible, increase production. But with price ceilings, higher prices are not an option. Additionally, companies maybe aren’t as greedy as politicians think and simply just can’t afford to lower price or, put differently, cannot produce a higher amount of it at this price because it may not be profitable and hence they’ll stop production and go out of business.
However, it may work for a brief period, just as in the 1970s when President Nixon implemented price controls. But the other side of the coin is that as soon as price ceilings get lifted, prices will shoot up again, just as they did back then.
Even the argument that price controls worked back pre-WWII when FDR set various price ceilings for different products is invalid. I’d argue that FDR’s price controls worsened the situation and prolonged the Great Depression, which ended (magically) just after WWII when the price ceilings were lifted.
And most definitely, they won’t work in an environment where input costs for businesses rise. Higher goods prices are the result of higher input prices. How should an electricity company afford to lower prices for its customers when their input prices rise?
Maybe the devastating experiences with price-controls happened too long ago for our politicians to remember. However, it's called stupidity if you do the same thing repeatedly and expect a different result. And the results will be the same as always and won’t turn things for the better.
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