Price Controls, Price Ceilings, and Price Floors

Introduction

Definitions and Basics

Price Controls, from the Concise Encyclopedia of Economics

Governments have been trying to set maximum or minimum prices since ancient times. The Old Testament prohibited interest on loans, medieval governments fixed the maximum price of bread, and in recent years governments in the United States have fixed the price of gasoline, the rent on apartments in New York City, and the minimum wage, to name a few. At times governments go beyond fixing specific prices and try to control the general level of prices, as was done in the United States during both world wars, during the Korean War, and by the Nixon administration from 1971 to 1973.

The appeal of price controls is understandable. Even though they fail to protect many consumers and hurt others, controls hold out the promise of protecting groups that are particularly hard-pressed to meet price increases. Thus, the prohibition against usury–charging high interest on loans–was intended to protect someone forced to borrow out of desperation; the maximum price for bread was supposed to protect the poor, who depended on bread to survive; and rent controls were supposed to protect those who were renting when the demand for apartments exceeded the supply, and landlords were preparing to “gouge” their tenants….

The reason most economists are skeptical about price controls is that they distort the allocation of resources. To paraphrase a remark by Milton Friedman, economists may not know much, but they do know how to produce a shortage or surplus. Price ceilings, which prevent prices from exceeding a certain maximum, cause shortages. Price floors, which prohibit prices below a certain minimum, cause surpluses, at least for a time. Suppose that the supply and demand for wheat flour are balanced at the current price, and that the government then fixes a lower maximum price. The supply of flour will decrease, but the demand for it will increase. The result will be excess demand and empty shelves. Although some consumers will be lucky enough to purchase flour at the lower price, others will be forced to do without.

Rent Control, from the Concise Encyclopedia of Economics

Rent control, like all other government-mandated price controls, is a law placing a maximum price, or a “rent ceiling,” on what landlords may charge tenants. If it is to have any effect, the rent level must be set at a rate below that which would otherwise have prevailed….

Minimum Wages, from the Concise Encyclopedia of Economics

Minimum wage laws set legal minimums for the hourly wages paid to certain groups of workers. In the United States, amendments to the Fair Labor Standards Act have increased the federal minimum wage from $.25 per hour in 1938 to $5.15 in 1997. Minimum wage laws were invented in Australia and New Zealand with the purpose of guaranteeing a minimum standard of living for unskilled workers. Most noneconomists believe that minimum wage laws protect workers from exploitation by employers and reduce poverty. Most economists believe that minimum wage laws cause unnecessary hardship for the very people they are supposed to help….

Agricultural Subsidy Programs, from the Concise Encyclopedia of Economics

Farm subsidies stimulate additional production of government-favored commodities by raising incentives to use scarce land and farmer talent on some products rather than on others. The specifics of the government program determine the degree of production stimulus; real farm programs are usually much more complex than the per unit production subsidies or price supports described in textbooks. Eliminating a subsidy for just one crop would cause production of that crop to fall much more than if all crop subsidies were eliminated simultaneously. Because most farmland would remain in use, economists would expect relatively small adjustments in total U.S. agricultural production if all farm subsidies were eliminated together, although some shifts in the mix among commodities would occur….

In the News and Examples

Policy Debate: Does an increase in the minimum wage result in a higher unemployment rate? From swcollege.com.

Minimum wage laws in the U.S. were first introduced during the 1930s in response to the Great Depression. This period was characterized by falling output, falling prices, and falling employment. The National Industrial Recovery Act (NIRA) of 1933 attempted to stop this downward spiral by encouraging the formation of trade association agreements that established price floors and minimum wages….

Introductory economics textbooks usually first introduce the minimum wage as an application of demand and supply analysis….

While minimum wage increases generally receive substantial public support, economists have generally relied on the above analysis to argue that such legislation will result in an increase in the unemployment rate in low-wage labor markets. In recent years, however, a series of studies by David Card, Alan B. Krueger, Lawrence F. Katz, and others have suggested that small to moderate increases in the minimum wage will have no adverse effects on unemployment (and may even lead to reduced unemployment)….

Unintended Consequences, from the Concise Encyclopedia of Economics.

The law of unintended consequences is at work always and everywhere. People outraged about high prices of plywood in areas devastated by hurricanes, for example, may advocate price controls to keep the prices closer to usual levels. An unintended consequence is that suppliers of plywood from outside the region, who would have been willing to supply plywood quickly at the higher market price, are less willing to do so at the government-controlled price. Thus results a shortage of a good where it is badly needed. Government licensing of electricians, to take another example, keeps the supply of electricians below what it would otherwise be, and thus keeps the price of electricians’ services higher than otherwise. One unintended consequence is that people sometimes do their own electrical work, and, occasionally, one of these amateurs is electrocuted….

McKenzie on Prices, podcast on EconTalk. June 23, 2008.

Richard McKenzie of the University California, Irvine and the author of Why Popcorn Costs So Much at the Movies and Other Pricing Puzzles, talks with EconTalk host Russ Roberts about a wide range of pricing puzzles. They discuss why Southern California experiences frequent water crises, why price falls after Christmas, why popcorn seems so expensive at the movies, and the economics of price discrimination.

Rent controls: David Henderson, podcast on EconTalk. July 30, 2007.

David Henderson, editor of the Concise Encyclopedia of Economics and a research fellow at Stanford’s Hoover Institution, talks with EconTalk host Russ Roberts about when and why economists disagree. Harry Truman longed for a one-armed economist, one willing to go out on a limb and take an unequivocal position without adding “on the other hand…”. Truman’s view is often reflected in the public’s view that economic knowledge is inherently ambiguous and that economists never agree on anything. Henderson claims that this view is wrong–that there is substantial agreement among economists on many scientific questions–while Roberts wonders whether this consensus is getting a bit frayed around the edges. The conversation highlights the challenges the everyday person faces in trying to know when and what to believe when economists take policy positions based on research. Is it biased or science?

Rent controls in Mexico City: Tepito’s Way, by Ibsen Martinez on Econlib

However, in Maracaibo, Medellín, Caracas, Colon, Guayaquil or San Salvador, as in many other Latin American cities, “barrio” almost invariably is shorthand for “populous, dangerous and smelly sinkhole on the fringe of civil society.” There are, of course, other accepted though more complex meanings of the word. Consider Tepito, in downtown Mexico City….

Munger on Fair Trade and Free Trade, podcast on EconTalk. Dec. 3, 2007.

Mike Munger, frequent guest and longtime Econlib contributor, speaks with EconTalk host Russ Roberts about fair trade coffee and free trade agreements. Does the premium for fair trade coffee end up in the hands of the grower? What economic forces might stop that from happening? They discuss the business strategy of using higher wages as a marketing strategy to attract concerned consumers. They turn to the issue of free trade agreements. If the ideal situation is open borders to foreign products, is it still worthwhile to negotiate bilateral and multilateral agreements that requires delays, exemptions and a bureaucracy to enforce? What is the cost of including environmental and various labor market regulations in these agreements?

Munger on Price Gouging, podcast on EconTalk. Jan. 8, 2007.

Mike Munger of Duke University recounts the harrowing (and fascinating) experience of being in the path of a hurricane and the economic forces that were set in motion as a result. One of the most important is the import of urgent supplies when thousands of people are without electricity. Should prices be allowed to rise freely or should the government restrict prices? Listen in as Munger and EconTalk host Russ Roberts discuss the human side of economics after a catastrophe.

Boettke on Katrina and the Economics of Disaster, podcast on EconTalk. Dec. 18, 2006.

Pete Boettke of George Mason University talks about the role of government and voluntary efforts in relieving suffering during and after a crisis such as Katrina. Drawing on field research he is directing into the aftermath of Hurricane Katrina, Boettke highlights the role of what he calls “civil society”–the informal, voluntary associations we make as individuals with each other to create community.

Ticket Prices and Scalping, podcast on EconTalk. July 16, 2007.

EconTalk host Russ Roberts talks about scalping and visits AT&T Park hours before Major League Baseball’s All-Star Game to talk with a scalper, a merchandiser, a fan, and the police about prices, tickets, baseball and the law.

A Little History: Primary Sources and References

Defense of Usury, by Jeremy Bentham.

In this very readable work, Bentham accomplishes two things. First, in an orderly manner replete with concrete examples he covers every possible objection to the regulation of usury (charging of interest rates that are apparently above the market rate), from religious restrictions that tainted the connotation of the word, to the economics of risk premiums. Second, throughout the work he champions those who are marginalized by society. He tears apart anti-Jewish bigotry. He argues strongly for the rights of the poor and even the feeble-minded to make their own choices in life. His emphasis on the ability of individuals to be the best judges of their own particular circumstances, and their right to use their own best methods for the pursuit of happiness, became the basis of modern utility theory.

Bentham’s ability to entertain his readers is well-illustrated in his classic horse-trading satire in Letter IX. Here, he uses the words of Sir William Blackstone (renowned jurist, whose works later became the basis of legal education throughout England and the United States) to highlight Blackstone’s own inconsistencies. Bentham’s sentence structures often seem ornate and overly-complex today. Yet, these very ornaments enabled him to spoof and poke at the foolish ideas of legislators and judges while maintaining decorum, delivering what we would today call “zingers”.

Advanced Resources

Munger on John Locke, Prices, and Hurricane Sandy. EconTalk Podcast.

Mike Munger of Duke University talks with EconTalk host Russ Roberts about the gas shortage following Hurricane Sandy and John Locke’s view of the just price. Drawing on a short, obscure essay of Locke’s titled “Venditio,” Munger explores Locke’s views on markets, prices, and morality.