Today's Markets & Price Control

In today’s society, markets are often unfair. Prices tend to be set by the market leader in the industry, and smaller firms have no say in the decision making process. In the worst case scenario, the market leader, who is able to benefit from economies of scale, will set prices to be so low that smaller firms will eventually be forced out of the market as they are unable to compete with larger firms. Thankfully, price controls are in place to prevent this from happening.

There are two types of price controls: price floors and price ceilings. Price floors are minimum prices set by the government when it believes that the market price is too low. On the contrary, price ceilings are set to prevent prices from exceeding a maximum. Both can be set at either above or below the current market price.

An example of a price floor would be minimum wage. Minimum wages ensure that all employees are being paid at least a certain amount for their work, and prevent businesses from exploiting workers. At the same time, they ensure that workers are able to maintain a certain living standard, and they encourage the jobless to seek employment. Yet no government regulation comes without its drawbacks. While minimum wages are able to increase the wages of employees, they also lead to an increase in the unemployment rate as some businesses may no longer afford to keep as many workers as before. Besides, employers will develop the mindset that higher wages should only be paid to those with more skills, and will hence disregard the unskilled, preventing them from finding jobs.

Price floors lead to problems when they are set above the market price. For example, an apple, originally priced at HK$5, now has a price floor of HK$10. While the higher price leads to an increase in supply, demand will also decreases. Producers who fail to identify this will begin producing vast amounts despite the drop in demand, harming their business. The only way for producers to gain from this policy is if their supply curve is inelastic, yet customers will continue to be harmed either way as they will have to pay higher prices.

On the other hand, rent control is an example of a price ceiling. Rent control is used to make housing more affordable for low-income tenants by ensuring that their rent does not exceed a certain value. If the price ceiling is set below the market price, demand for rented properties will increase as they become less expensive. However, in the long run, the supply of rented housing may decrease as construction companies will be dissuaded by the lower profit margin earned from building such housing. Meanwhile, landlords may stop maintaining their properties in order to save costs, and because they no longer have to worry about demand. The excess demand and limited supply created will in turn cause a shortage of rented housing, meaning that some customers may be left homeless or forced to purchase property.

The shortage of goods means that customers will have to buy on a first-come-first-served basis, and encourages illegal activity. Back in the 1970s, the American government set the price ceiling for gasoline below the market price. Suppliers began selling on a first-come-first-served basis, and customers had to wait in long queues to buy gasoline. While gasoline may have been cheaper than before, its actual price – which includes both the price paid for gasoline and the time spent queuing – was actually higher than if a price ceiling had not been set. Besides, it encouraged illegal behaviour as some customers would pay bribes to suppliers in order to reserve gasoline for themselves. Gasoline also began being sold on the black market where prices weren’t controlled and were often above the original market price, as the price reflected the desperation of customers and the high risk of operating illegally.

By using price controls, suppliers will no longer have the incentive to improve quality and to cut costs. They may instead choose to avoid price controls by reducing the quality of their products, such as by using lower quality raw materials, creating smaller products, or as seen from the example of rent control, landlords will stop maintaining their rented properties. The government can prevent this from happening by implementing quality and product standard regulations, yet this will cause their expenses to increase tremendously.

The drawbacks of price controls often lead governments to introduce rationing. Coupons will be given to every household, and will allow them to buy a certain amount of the product. For example, each driver may receive a coupon allowing them to buy 5 litres of gasoline at a time. The use of coupons can also prevent illegal activity. Suppliers will be prevented from dealing on the black market as they will need to have coupons to match their production, and customers are less likely to pay high prices on the black market as they are guaranteed a certain amount.

Unfortunately, rationing comes at a cost. The government will need to regularly adjust rations to cope with fluctuating supplies and demands, as well as individual needs, which is both time-consuming and expensive. In World War II, local bureaus in America were given the permission to issue extra rations to those in need, yet this also led to the problem of corruption and favoritism. Economists have suggested allowing citizens to buy and sell their coupons, so that those in need can buy extra coupons from others more well-off, helping to improve the livelihoods of the buyers, while providing additional income for the sellers.