When Price Ceiling is Justified?

The price ceiling, historically, was used first by Egyptians 4000 years ago followed by the ‘Code of Hammurabi’ in Babylon and adopted by Zhou dynasty in China. Ancient Greece developed a set up of food inspectors to control prices of the essential commodities for the first time. The modern public managers are still bewildered by the hypnotic appeal of the price controls for essential products to make them accessible to the most underprivileged section of the society on ‘fair prices.’ They exercise their hearts and power in favor of the most pressed buyers against the unscrupulous sellers through price controls.

Price Ceiling

Despite all-out political support, popularity, and kindness, the price ceilings have not been yielding results for last 4000 years. They can’t be termed as a complete failure in certain situations.

“Many economists concede that government controls can restrain prices for very short periods of time, the result is that pent-up inflation bursts at the first opportunity, giving rise to even higher prices in the long run. This effect has been recognized at least since the very beginning of our Republic. John Adams wrote to his wife in 1977 that “I expect only a partial and temporary relief from [rising prices using controls] and I fear that after a time the evils will break out with greater violence. The matter will flow with greater rapidity for having been dammed up for a time.” (Forty Centuries of Wages and Price Controls, How not to Fight Inflation by Schuettinger, Robert L. & Butler)

Reasoning for Price Ceiling

While freezing prices of different products and even the wages in the 70s, Republican President Nixon gave the following reasoning:

"…there is one great problem that rightly concerns every one of us, and that is, as you know, rising prices, and especially rising food prices. By the end of last year, we had brought the rate of inflation in the United States down to 3.4 percent. That gave us the best record in 1972 of any industrial country in the world. But now prices are going up at unacceptably high rates. 

The most considerable part of this increase is due to rising food prices. It has been caused in no small measure by increased demand at home and abroad, by crop failures overseas, and as many people in various areas of the country know, by some of the worst weather for crops and livestock that we have ever experienced. But whatever the reasons, every American family is confronted with a real and pressing problem of higher prices. And I have decided that the time has come to take strong and effective action to deal with that issue. 

Effective immediately, therefore, I am ordering a freeze on prices. This freeze will hold prices at levels no higher than those charged during the first eight days of June. It will cover all prices paid by consumers. The only prices not covered will be those of unprocessed agricultural products at the farm levels and rents. 

Even those economists who had never supported price controls have admitted that Nixon’s measures were successful for a bit longer time due to a monopolistic style of enforcement. Yet nobody can deny that these measures of the Nixon’s administration met the same fate at the end of the day as any price control measure in the history. Long queues, shortage of products and rise in demand were common phenomena. When the government relaxed controls, the price hike was much more than could be in a natural process.

But no economist on the earth is found favoring price ceiling as a permanent policy measure to control prices, inflation, and efficiency. On the other hand, the public managers also have a case for price ceiling.

Suppose if a few people in a society can afford to purchase a 20 kg bag of flour for $100.00, it does not permit the sellers to raise prices to the level where people had no such wealth are deprived of purchasing the flour. However, if the situation which causes such price hike (like a war or drought) continues and result in a shortage, the public managers will have to increase the price ceiling to find an equilibrium price. If such situation is temporary, the supply and demand factors shall find out a point of equilibrium price where price ceiling can be relaxed.

Similarly, when a market failure takes place due to information asymmetry or monopoly, the public managers can use the tool of price ceiling to allow entry of competitors. However, they will have to face severe problems for enforcement.

An Unhealthy Measure for Economy

Price ceiling has a huge attraction for public managers and electronic and print media. They can provide immediate but temporary relief to the targeted population. However, no such measure in the economic history has ever proved successful to remove the problem. 

Economists hesitate to take subsidies as a healthy measure to counter high inflation, price hike, and poverty. First, the public managers may not identify imperfection in the market. Even if they identify, they often fail to fix an "exact price" that can remove the perfection. Furthermore, they can’t provide adjustment and enforcement to the changing circumstances and consumers’ behaviors. It is free marketing forces that may bring such ideal results. 

You need to remember all the times that supply and demand are basic building blocks for economic efficiency in any open market. Many sellers and well-informed buyers in a market can easily settle a ‘fair price’ for an essential commodity in open competition and copyright environment. It is not only better than the imaginary ‘fair price’ settled by any public manager but also economically efficient for the whole country and the system. According to Rockoff:

“One would expect that as markets grew, producing a smoother flow of information … the need for regulation would have decreased. Indeed that seems to have happened.”

References

* More on Price Ceiling and Controls

* http://www.econlib.org/library/Enc/PriceControls.html

* http://www.presidency.ucsb.edu/ws/index.…

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