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