Chapter 3: Messing with the Market

When we take important things for granted because they work so well, we often don't really appreciate them until something goes wrong. Certainly, we never appreciate our health more than when illness interferes with the proper functioning of our bodies. Similarly, one of the best ways to appreciate how well the market economy works is to consider the consequences of policies that interfere with it.

Price Controls

No matter how well price communication works, people will be dissatisfied. The unrelenting message of market prices is "Scarcity is real— take it seriously." This is not a message we enjoy receiving. Despite the impressive social coordination enabled by market prices, buyers always wish prices were lower and sellers always wish they were higher. Governmental officials sometimes respond to complaints about high or low prices by imposing price controls.

Gasoline Price Controls
In the 1970s, the federal government responded to consumers' complaints about rising gasoline prices by imposing ceilings on the price of gasoline. The price increases resulted from the normal working of price communication when the Organization of Petroleum Exporting Countries greatly cut the cartel's exports to the United States.

OPEC's action reduced the oil available to American refineries, which reduced the gasoline available to American motorists. This meant that consumers wanted more gasoline than was available. So consumers communicated to producers that they wanted more gas—and to each other that everyone should use gas more sparingly—by bidding up its price.

Left alone, the adjustment would have continued until producer and consumer desires were in balance. This could have been achieved by producers finding new, but more expensive, sources of petroleum and spending more to obtain additional gasoline from each barrel and by consumers reducing their gasoline use by driving more slowly, carpooling more, relying more on mass transit and employing other energy-saving measures.

But consumers disliked this message of scarcity and sought immediate relief. Congress responded by putting a ceiling on the price of gas, preventing it from reaching the market level that would have balanced the amount supplied with the amount demanded.

Unfortunately, the price ceiling didn't provide relief. In fact, by outlawing price communication, the ceiling caused consumers to pay far more for gas than they would have paid without it. That's right: The price ceiling that was billed as a way to protect consumers against high gas prices increased the cost of gas.

Both consumers and producers would have been better off without the price ceiling. Consumers could have communicated their desire for more gas with a higher price, and producers could have sold more gas at a higher price.

Because consumers wanted more gas than was available with the price ceiling, the marginal value of gas to them was greater than the controlled price. Without the ceiling, producers would have responded to the higher demand by increasing the amount of gas available. This would have lowered the marginal value of gas and therefore lowered the price people were willing to pay. But the price would still have been higher than the price ceiling.

So how can we say people would have been better off without the price ceiling? The answer is competition among consumers.

Just because consumers can't legally compete for additional gas by paying a higher price doesn't mean they can't compete. As discussed in Chapter 1, in our world of scarcity, competition is inevitable. With price controls, people commonly compete by waiting in line. How long will people wait? In our gasoline example, they will wait until the cost per gallon (the controlled price plus the opportunity cost of their time) is equal to its marginal value to them. Since the price ceiling increased the marginal value of gas, the cost of gas ended up higher than it would have been without the ceiling.

Consumers clearly communicated their desire for more gas through their willingness to endure long lines. This communication allowed consumers to inform each other that it had become more important to conserve gas, but it didn't motivate mutual accommodation and cooperation. Instead, it created tremendous hostility among consumers. Fights between people frustrated by long lines were common during the gas shortages.

When consumers communicate the desire for more gas by waiting in line, it does nothing to motivate suppliers to respond to their desires. The cost of waiting in line is simply wasted, since it neither motivates nor provides the means for suppliers to make more gas available and make it available more conveniently.

Discrimination and Favoritism
Outlawing price communication with price controls also increases the likelihood of discrimination and favoritism. Without price controls, it is costly for sellers to discriminate against minorities, women, the handicapped or any other group. Refusing to sell to them reduces the number of potential buyers. Therefore, those who discriminate have to either sell for less or sell fewer units than those who don't.

This doesn't mean sellers won't discriminate when there are no price controls; obviously, some do. But price controls increase discrimination by lowering its cost. Since buyers are anxious to buy more than sellers are willing to sell when a ceiling keeps the price below its market level, it costs sellers nothing to discriminate against some people. They can discriminate and still sell all they want at the controlled price.

This type of discrimination was widespread with the price ceiling on gasoline, as was favoritism. Before opening to the general public each day, station owners would let family members and friends fill up, even though this was illegal and meant less gas for other customers.

Rent controls, common in some parts of the country, are another form of price ceiling and create the same shortages and higher cost for consumers. Rent controls also lower the cost of discrimination since there is always a long list of people anxious to get rent-controlled apartments.

Favoritism and discrimination are common ways to ration rent-controlled housing. People who are members of groups that tend to be discriminated against are less likely to get an apartment than those who are members of advantaged groups, have connections or are in a position to return favors.

Price controls don't always put ceilings on prices, holding them below market levels. Price floors set prices above market levels.

Like price ceilings, price floors lower the cost of discrimination and favoritism, but they lower this cost to buyers rather than to sellers. A price floor higher than the market price creates a surplus, with sellers anxious to sell more than buyers want to purchase. So it costs buyers nothing to discriminate against certain groups of sellers by refusing to buy their products or services.

An example of this type of discrimination is caused by minimum-wage laws, which keep wages for some workers (usually the young and unskilled) above the equilibrium wage. More people are looking for work (trying to sell their services) at the minimum wage than employers are willing to hire. As a result, employers (buyers) can hire more workers (sellers) than they want at the minimum wage, and so it costs them nothing to discriminate by refusing to hire women or minorities.

The Censorship of Price Controls

Price controls are a harmful form of censorship because, as we have seen, they hamper the price communication that allows people to make the best use of our scarce resources through coordination and mutual accommodation. Consider the following examples of price censorship.

• Minimum-wage laws. Minimum-wage laws censor unskilled youth who would like to communicate the following to potential employers: "I have few skills, and college is not possible for me. Because of this, I am willing to work for a low wage now, while I have few financial responsibilities, to acquire the on-the-job training that will allow me to be more productive later."
  
  This censorship does far more harm to teenagers from poor families —who are more likely to be discriminated against and more dependent on an entry-level job for training—than it does to teenagers from families with higher incomes.
   
• Agricultural price floors. Agricultural price floors harm many children by censoring the ability of dairy farmers, for example, to communicate to parents, "I can lower my cost of production, which will allow me to make more milk available to you and your children at a lower price."
  
  This censorship is particularly harmful to poor children because their parents devote a larger percentage of their budgets to basic foods than do parents with higher incomes.
   
• Rent controls. The censorship of rent controls prevents people from communicating their desire for housing space by sacrificing more of other things. The result is that people who would be willing to provide additional housing don't have adequate information on how valuable the housing is and little motivation to provide the right amount, even if they did.
  
  Rather than helping the poor—the purported beneficiaries of rent controls—the available housing stock generally goes to well-connected, nonpoor families. The poor end up with less housing—and housing in more dangerous neighborhoods—than they would have been willing to pay for.

Pointing out the harm done by wage and price controls doesn't mean we have to be complacent about low wages, low farm incomes or high rents. It's simply recognizing that these are not the problems but the messages communicating information on the problems. Low wages inform us that productive skills are lacking, low farm incomes send a message that some farmers would create more value elsewhere in the economy, and high rents tell us housing stock should be expanded.

We may not like the news communicated through market prices, but that is no reason to censor it. Who would suggest that we censor news of natural disasters, political and business scandals, the horrors of genocide or devastating epidemics? We may not like to hear such news, but suppressing it would hamper responses that lower the costs and reduce the probability of such events.

Similarly, censoring price communication reduces the information and incentives needed to respond effectively to the problems created when our efforts and resources are not directed into their most valuable uses.

Some may argue that freedom of price communication puts those with few financial resources at a disadvantage. This argument is true in the same way as saying that freedom of expression disadvantages those lacking the education and ability to express themselves well. But no one is put at an absolute disadvantage by the freedom to communicate through either prices or words. The best hope for the poor is through the free flow of market communication, which informs them of their best opportunities, motivates them to increase their productivity by taking advantage of those opportunities, and keeps others responsive to their preferences and concerns.

Another objection is that price communication is often inaccurate. True enough. No one would argue that price communication is always completely accurate and honest. But who is prepared to argue that distortions and misrepresentations are not common in politics, news and advertising? Such imperfections can never be eliminated, but the most effective way to moderate them is not through censorship but through the competition of free expression, as any defender of freedom of speech will tell you.

Similarly, the most effective way to moderate the imperfections in price communication is to allow more competition in price communication, not stifle that competition with price censorship.

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