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Monday, August 29, 2011

Controlling Prices to Our Detriment

As the East Coast recently prepared for Hurricane Irene the state once again “heroically” stepped in to protect people from the evils of “price gouging.” Anti-price gouging laws went into effect (see here for one example) in order to control prices and thus protect consumers. The usual story goes that greedy businessmen raise prices on essentials in times when people need them most. The price becomes too high for the poor to be able to afford the basics such as water, batteries, flashlights, etc. This, in the common view, is beyond greedy; it is evil and heartless, denying individuals with what they need in times of crisis.

How accurate is the above story? It certainly sounds plausible. But is the real picture as black and white as the story suggests? Is it really the greedy businessmen vs. the powerless consumers? Is the government really helping?

In today’s document, the cliché of Socialism number 58 “Government should control prices, but not people,” Dean Russell points out that attempts at price controls require coercion on real people. Too many individuals divorce human action from prices and don’t see that the government does not control the price of commodities but rather controls the sellers of those commodities through coercion.

It might be argued that this is all well and good but in times of crisis, such as in preparation for a hurricane, coercion is necessary. Individuals, especially the poor, need to be able to afford certain items to help them get through the coming crisis, so government should control sellers to stop the price from rising.

This logic, however, is incomplete. Even if we assume that businessmen are completely greedy the increased price still services an important purpose. To see this purpose we must turn to basic economics.

As the hurricane approaches individuals’ demand for certain commodities, such as water, batteries, canned food, etc. increases, meaning they would like to buy more of these goods. This gives sellers an incentive to raise the price, as the goods began to fly off the shelves much faster than usual. While the motivation to raise the price might be purely greed-based, it actually benefits consumers and society as whole. The increased price has two important functions. First, it induces sellers to supply more of the good. At the higher price sellers will increase the quantity of the good, thus providing more of the good for individuals to buy (satisfying the increased demand). Second, it discourages other consumers from buying too much of the good. In other words, the higher price helps ration the good amongst more individuals. Demand curves slope downward, meaning the lower the price the higher the quantity each individual will buy. By raising the price each individual will by less of the good than if the price were to remain at the pre-storm level, leaving more for others. Thus, in an unhampered market, the price rises and more consumers get what they need.

If the government stops sellers from increasing the price then a shortage will ensue. Why? Well first, demand has risen but sellers are still only willing to supply the same amount as the pre-storm level. Thus eliminating the advantage of the increased quantity supplied mentioned above. Second, with the increased demand consumers see the lower price as an incentive to take more for themselves. Their motivation to conserve and take less (leaving more for others) is eliminated. This creates the shortage. Meaning many individuals will find the shelves completely empty when they arrive at the stores. The result is that more individuals will go without the very necessities the government, in enacting the price control, is trying to make sure they can get.

From this we should, even in cases of emergency, question the use of coercion to support prices. The price system after all channels resources to their highest valued use, benefiting society. In coercing certain individuals to maintain a certain price, the price system is distorted and channels resources from, not to, their highest valued use, which hurts many people. It should be clear that voluntary interaction tends to work better than coercion and this is especially true in the market.

Download the clichés of socialism number 58 here.

  • Nicholas Snow is a Visiting Assistant Professor at Kenyon College in the Department of Economics, and previously a Senior Lecturer at The Ohio State University Economics Department. His research focuses on the political economy of prohibition.