Freeman

ARTICLE

The Economics of Price Fixing

JUNE 01, 1967 by D. T. ARMENTANO

Dr. Armentano is Assistant Professor of Eco­nomics at the University of Connecticut in Hartford.

Almost every piece of price-fix­ing legislation produces results opposite to those intended. Wheth­er one examines the outcome of interest rate regulation or mini­mum wage legislation, the lesson repeats itself; interferences with the price system lead to unin­tended and unexpected conse­quences. And more, the conse­quences aggravate the original situation the legislation had meant to ameliorate. Finally, the aggra­vation caused by the initial legis­lation generates further clamor for bigger governmental programs and stiffer Federal controls.

At this point even the most in­formed citizen loses the ability to differentiate sense from nonsense. Thoroughly confused, he resigns himself to the fact that free en­terprise has obviously failed, and that like it or not, it’s time that the government "did" something. He is usually completely unaware that it is the government inter­vention which has failed, and not the free market. The following analysis will attempt to highlight the evidence for this contention.

The most important function of a free price (a price not fixed or regulated by the state) is its ability to serve as an indication of the relative scarcity of a com­modity, and automatically ration that scarce commodity to the high­est demander. As long as the price of an article is allowed to fluctuate and match the supply with demand, there will be neither surpluses nor shortages, i.e., the market will be cleared at some equilibrium price.

Government price-fixing de­stroys the clearing and allocating function of prices. By permanently fixing prices above or below their equilibrium values, the regulation prevents the equating of the avail­able supply to the demand. Thus, short-run surpluses or shortages become inevitable. Even worse, the signals sent out by the fixed prices to the respective consumers and producers encourage inappro­priate economic activity which tends to aggravate the original situation.

As an example, when copper prices are pegged below their equilibrium level, a short-run shortage is likely. What is worse, low prices encourage an increase in the demand for copper, as po­tential users switch away from relatively higher priced substi­tutes. Likewise, low copper prices discourage the production of copper — already in short sup­ply — since the low prices fail to cover the expected costs of copper production. In a double edge fash­ion, therefore, the future short­ages of copper are exaggerated. Still worse, the excess demand created by the artificially fixed price of copper spills over into other commodity markets where it tends to push up the prices of other commodities or, if these prices are also fixed, cause addi­tional shortages.

Shortages and Surpluses

The confusing consequence of selected price fixing is a combina­tion of shortages on the one hand and price increases on the other. Although ration cards may be used to link available supply to demand, they neither eliminate the excess demand nor increase the deficient supply. Only a free­ing of the fixed price can induce the proper economic responses from both buyer and seller. Whether the subject is a water shortage (the price has been fixed at zero for decades), an apparent shortage of city apartments (rent controls), or a money shortage (interest rate regulation), the consequence of fixing prices below their equilibrium values is only too obvious.

Similarly, prices fixed above equilibrium generate surpluses. The inescapable consequences of a farm program or a minimum wage bill are farm surpluses and labor surpluses. Nor is this the end of the mischief; there are deeper and more intangible eco­nomic consequences beneath the surface. Unwanted farm surpluses are composed of scarce economic resources or factors of production, and these could have gone into the production of something that con­sumers really wanted. Likewise, unemployed labor is totally unpro­ductive; if employed, no matter what its wage or productivity, it could have contributed to the pro­duction of needed output. Both artificial surpluses are an econom­ic waste; in a world of unlimited human wants and limited factors of production, they are an econom­ic tragedy of the first order.

Making Crooks of Those Who Serve

As a final point, price-fixing in­duces economic and political be­havior which attempts to circum­vent or exploit the consequences of the artificial price. Black mar­kets develop and substitute for "free" markets; consumers and producers who wish to buy and sell on mutually agreeable terms become lawbreakers. Those sell­ers of goods or factors with arti­ficially high prices seek to extend their advantage through addition-al legislation. With premiums on pressure-group tactics, and penal­ties on legitimate enterprise, a de­terioration of the proper atmos­phere for economic activity is in­evitable. In addition, the public becomes confused, and the confu­sion mistakenly ferments into a distrust of capitalism. The rest of the story is the economic history of the last seventy years.

To a careful observer, the facts are clear. Fixing prices of partic­ular products or factors can only serve to generate surpluses or shortages, trigger price increases in selected markets, and continue to misallocate scarce economic re­sources. It is time that students of society concerned with wealth and welfare placed the responsi­bility for these evils where they rightfully belong.

 

***

The Law of Duty

No man, I affirm, will serve his fellow-beings so effectually, so fervently, as he who is not their slave; as he who, casting off every other yoke, subjects himself to the law of duty in his own mind…. Individuality or moral self-subsistence is the surest foundation of an all-comprehending love. No man so multiplies his bonds with the community as he who watches most jealously over his own perfection.

WILLIAM ELLERY CHANNING, May 26, 1830

ASSOCIATED ISSUE

June 1967

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