The Concise Guide To Economics
by Jim Cox
7. Price Controls
Price controls are the political solution enacted to stop price inflation. [See Chapter 21 for an explanation of the cause of inflation.] The controls do not work. Prices are determined by supply (willingness and ability to sell) and demand (willingness and ability to buy). The price resulting from supply and demand which clears the market is not changed by a price control (a legal limit on price). The legal price is merely a misstatement of the actual conditions and is comparable to plugging a thermometer so that it never can read greater than 72 degrees even though the actual temperature may be higher. The law of supply and demand cannot be repealed.
People will call for price controls as a way to make goods available cheaper than they otherwise would be. The price controls do not make the goods cheaper and in fact cause a shortage of those goods as the demand quantity will be greater than the supply quantity. Not only do price controls cause shortages but they in fact make goods MORE expensive!
How can this be? The shortage resulting from the price controls causes consumers to pay for the good in question in ways other than a price payment to the seller. To take an example from the experience in the U.S.: the price of gasoline was legally limited between August 1971 and February 1981. At a time when gasoline could not be legally sold for more than 40 cents a gallon, the estimated free market -- supply and demand -- clearing price was 80 cents a gallon. Using a ten-gallon fill-up it would appear that the consumer is saving $4.00 per tank full (10 gallons x 80 cents versus 40 cents). While consumers are not paying as much to the seller for the gasoline directly, they are in fact paying dearly for the gasoline in other ways.
Probably the greatest expense is in the form of the consumer's time. The shortage results in extensive time spent waiting in line for the purchase. Time is money; a consumer's time has value. Using a minimum figure of the consumer's time being worth $2.00 per hour, a two-hour wait in line per fill-up wipes out any alleged saving from the price controls. But the consumer is not through paying. The idled gasoline used waiting in line is another form of consumer payment, say 10 cents per fill-up. Now we have the price controls actually costing the consumer an extra 10 cents per tank full. And there are yet more costs to the consumer. There is a difficulty in buying gasoline when there is a shortage in that it takes extra mental energy and planning which is an aggravation (that is, a cost) for the consumer he would much rather avoid. (Doubt this last point? Check your own behavior: Do you call around to the gas stations in your area before stopping for a fill-up, or do you avoid that aggravation although you know that not checking will often result in paying a higher price than necessary?)
These extra expenses continue in the form of the violence and the fear of such violence that can result from tensions mounting while waiting in long lines for gasoline (shootings did occur in this situation during the 1970's price controls). Other expenses might include the purchase of a siphon hose for legitimate or even illegitimate gasoline transfers from one vehicle to another. Also, siphoning gasoline carries its own severe health and safety costs when poorly executed!
The fact that there is more demand than supply of gasoline generates a further consumer cost in reversing the normal buyer-seller relationship. The normal buyer-seller relationship is one of the seller courting the consumer, attempting to please the consumer as a means to the seller's financial success. But with the price control-induced shortage it is the buyer who must please the seller to be among the favored whom the seller blesses with his limited stock of goods! In the 1970's this reversal was played out as sellers dropped services from their routine -- no more tire pressure checks, oil checks, windshield cleaning, etc.
All of these further consumer costs only make the expense of gasoline that much greater than the free market price. Consumers have the choice of paying the free market price for gasoline in dollars directly to the seller or paying an even higher controlled price in a combination of dollars and other costs. But there is a difference in these two forms of payment for gasoline. The difference is that the direct dollar payment to the seller is an inducement to supply gasoline. The payment by the consumer in other costs encourages no such supply.