Why Government Price Mechanism Does Not Work?

The price mechanism is governed by supply and demand forces in a free market. However, the rulers and public managers have been trying in vain for last 4000 years to enforce prices what they consider fair for the poor in society. You have seen previously, the government’s efforts results in uncertainty, instability, high demand, shortage of the products and rationing. Besides, such price controls may lead to the following problems:

Black Marketing

When natural price mechanism is distorted with government intervention, the sellers, as well as consumers, find some incentives in evasion of the controls. Whenever the government control weakens the black markets come into being as sellers want to make more profit which they can’t make due to price controls imposed by the government. They divert their resources to the black market for maximization of profit.

On the other hand, the consumers also have certain incentives to pay more than fixed by the government. For example, when rent controls are imposed, the owners of the residential buildings don’t spend sufficient amount of money on the renovation of their properties to be rented out. To get good conditioned residential properties, the consumers shall happily pay a bit more money than the fixed prices.

Generally, the price of goods and service in the black market is higher not only than the prices fixed by the public managers but also in the open market. The main reason behind such difference is the shortage of the product, a desire of the sellers for maximization of profits, avoidance of long queues and risks involved in selling the product on the black market.

Cost Involved in Price Controls

You will find the economists rarely supporting the elimination of natural price mechanism for ‘fair prices.’ However, even if you see one, you can’t deny the massive costs which are involved in enforcing the fixed prices. The situation worsens when the incentives are too many, and the supply of the product is little vis-à-vis the demand. The government would need substantial bureaucratic set up to enforce fixed prices. Greeks were the first perhaps to provide grain inspectors to implement prices of grain in the market. There is strong evidence that resources consumed by the bureaucracy to enforce government price mechanism are more than price increase in a free market. The consumers have to pay the benefits on prices back in shape of taxes.

In Pakistan, the executive officers are granted judicial power to try the violators on the spot. They take help of the local police, clerical staff, and other officials in the process. They not only avoid their routine duties but also consume a significant portion of their working hours enforcing price controls. This result is wastage of time and resources for those clients waiting in their office for their petty issues.

Quality and Price Controls

The easiest way to avoid price controls is the reduction in quality of the products. The availability of low-quality food, pulses and other essential items on fixed prices is a common practice in many cities of Pakistan. The low-quality food items may lead to health hazard which involves much more cost to recover from the damage caused.

To enforce quality of the food items, there is another chain of bureaucracy which includes food inspectors, laboratories, and chemical examiners. It takes a lot of time and resources to bring the culprits to the justice on the issue of quality of food items.

Most of the economists agree that price fixing can provide temporary relief to a section of society but costs involved to implement the controls is much higher than the benefits which consumers receive.

Tying Up with Other Products

The Utility stores running under Federal Government of Pakistan offer essential commodities like flour, sugar, pulses, etc. on control prices. Resultantly, the Utility Corporation has to face huge losses. To reduce the losses, the Corporation ties up high margin products with the price-controlled commodities.

Tying up of products is a common practice even in the open market. When companies introduce a new product, they sell two products at the price of single one. Once the product creates its marketing, the promotional offers are withdrawn.

Effects on Prices of Uncontrolled Items

It is not easy for a government price mechanism to fix prices for all products. Generally, a few items are selected for price fixing while leaving a lot of them on the market. It causes prices of the uncontrolled sector to rise higher at the cost of the controlled prices. Moreover, the business resources follow the sector where more profit is offered.

The effort of the private sector to tie up controlled items with uncontrolled sector products is another way to avoid price controls.

Ration Cards

Whatever arguments are forwarded, the public managers can’t get rid of the idea of price controls when the market fails, or political needs arise. That’s why some economists propose that rationing should not be an outcome of price controls but a part of the price mechanism.

After 1971 war between India and Pakistan, the Prime Minister of Pakistan Zulifqar Ali Bhutto adopted rationing for sugar and flour which provided relief to a lot number of people during this period. But good rationing system needs identification of the people who at or below a certain level of income. Besides, the rationing system should be used carefully for a limited number of items. It shall reduce chances of sellers to sell the products on the black market.

But there are certain problems attached to ration cards as well. The first and most important is that public managers don’t find a scientific way to find out the price which can tackle consumers’ individual choices, changes in weather and supply and demand factors. Furthermore, the rationing provides incentives to the sellers to sell out rationed items in the open market and prepare the record in collusion with consumers who might have an excuse for more income.

Some experts propose that this situation can be handled with the creation of a competitive market for ration cards where consumers can sell their cards in the free market for anything as they like. This will generate additional income for the ration card holders on the one hand and profits for the sellers. This method can’t control the corruption in ration card system.

Why Government Price Mechanism Fails (1)

A Case of For Price Controls

Rationale for Price Controls

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