In this September 12th, 2005, column for the Pittsburgh Tribune-Review I do my best to explain the ill unintended consequences of government-imposed price ceilings. The column is beneath the fold.
Capping gasoline prices
The recent rise in gasoline prices has many people calling for price caps. One man interviewed on a local radio station wondered aloud “if the time is right to use price controls to keep gas affordable.”
I cannot say this strongly enough — price caps are a curse to consumers. They increase consumers’ costs of acquiring goods and services.
Prices are determined by the interaction of consumers’ buying decisions (“demand”) with producers’ production decisions (“supply”). If buyers decide that they now want to use more of a product than before, their attempts to acquire greater quantities of this product will bid its price up. This higher price is beneficial because it inspires producers to do just what consumers want — namely, supply more of the product.
Likewise for changes in supply. If a hurricane damages oil rigs and refineries, the price of gasoline will rise to reflect its now-greater scarcity.
Market prices reflect a deeper reality summarized by the terms “demand” and “supply.” They also prompt buyers and sellers to act in ways consistent with this reality. Whenever available supplies of gasoline fall, the resulting higher price for gasoline reflects this reality while it prompts producers to search for new sources of supply and prompts consumers to use gasoline more carefully.
Capped prices, in contrast, generate a distorted reflection of reality, causing buyers and suppliers to act in ways inconsistent with it.
Suppose Katrina causes the market price of gasoline to rise to $4 per gallon. If government enforces a price ceiling of $2.50 per gallon, consumers will be misinformed about the relative scarcity of gasoline. They will act as if gasoline is more abundant than it really is by trying to buy too much of it (given its diminished supply).
This problem of excess eagerness to consume is compounded by the price ceiling causing producers to ignore the true, higher value of gasoline and, instead, act as if consumers value it at only $2.50 per gallon. Less gasoline will be supplied at $2.50 per gallon than at $4 per gallon.
The consequence is a lasting gasoline shortage.
A shortage itself is bad enough. But shortages always are accompanied by additional, less visible problems.
One such problem is consumers’ extra expenditure of time and other nonmonetary resources on efforts to acquire gasoline.
For example, when lines form at gasoline stations — as they did during the 1970s when price controls were in effect — people spend extra time attempting to buy gasoline. Because time is valuable, spending it waiting in line is a serious cost to consumers. What determines how much time and other nonmonetary resources consumers spend to get gasoline in short supply?
The answer is gasoline’s market value. The higher it goes, the more time and other nonmonetary resources consumers will spend attempting to gets gasoline.
Now, you might think that a price ceiling lowers gasoline’s market value — but that would be mistaken. The reason is clear. By reducing available supplies of gasoline, a price ceiling makes gasoline scarcer. Whenever something becomes scarcer, its value rises. It becomes more precious to consumers, who compete more ardently to get hold of the few available units.
Not allowed to pay more money for the product, consumers compete for it in other ways, such as by rushing to gasoline stations and waiting in long lines.
Because the price ceiling raises gasoline’s market value, the total value of resources — such as time spent waiting in lines — that consumers spend to acquire gasoline rises.
In short, a price ceiling makes gasoline more, not less, costly.
The story gets even worse. Price ceilings increase the importance of personal and political connections. People who know the owner of a gasoline station, or people with political power, can exploit their personal relationships and power to ensure that they get special access to gasoline in short supply.
Ideally, of course, such relationships and power would be irrelevant in determining who buys gasoline. But only the most naive romantic pretends that such relationships and power play no role.
Is the typical gasoline retailer likely to ignore his sister-in-law’s plea that he put aside a few extra gallons for her? Is this retailer likely to be immune to the pressures that the mayor or members of the city council exert on him for favored access to his gasoline?
As Thomas Sowell often reminds us, reality is not optional. By masking reality, price controls only make matters worse.