One of the basic insights of a typical microeconomics class is why price ceilings (and floors, for that matter) can be such a bad idea. I'm ramping up to teach our Executive MBA students this summer, so this article from Saturday's New York Times caught my eye.
Venezuela's populist leader Hugo Chavez --- concerned about keeping the poor happy in a country with severe income inequality and an upcoming election --- has pushed through mandatory price cuts on certain basic food staples. The idea is that if milk and juice costs less, then the poor will be better off.
But of course the problem is that suppliers make decisions based on the price they will receive when selling goods and services in markets. And if that price falls, then suppliers react by making fewer investments, reallocating resources to more profitable markets, producing less, etc.
To tie this back to a lines-on-a-chart supply and demand analysis, the mandatory price cut will move us down and to the left on the industry supply curve. And at the same time, lower prices will cause consumers to shift their demand toward these staple goods, moving down and to the right on the demand curve. At the government-mandated-low-price, the quantity of milk demanded by consumers will exceed the quantity of milk supplied by the market.
"Excess demand" can seem like an abstract concept when presented in a lines-on-a-chart fashion to students, but it's not at all abstract for the people of Venezuela: According to the article, in March 42% of stores had no powdered milk.
Imagine this: You have two young kids and you're going through milk like crazy. And... where you gonna get it? You have to visit probably two and sometimes three stores, just to feed your kids. This constant, time-wasting search for daily products is just not something we (usually) deal with here in the US... And you can thank the fact that prices are free to move to equate supply and demand. Think about that next time you hear a call for government regulation to stop "price-gouging" in the market for gasoline.
And let's not even think about the ramifications of the Venezuelan toilet paper shortages.
Yes, it's socialism, right here in the western hemisphere... Where is the Monroe Doctrine when you need it?
But before we get on our high horse and lecture the rest of the world about the virtues of free markets and how competitive the US economy is, let's recall that we do the exact same thing here in the good ol' USA. In today's New York Times, there's a nice article about how the Supreme Court has refused to hear a challenge to New York's long-standing "rent stabilization" law. That's right, New York State is doing to rent what Chavez is doing to powdered milk, by restricting how quickly landlords can raise rents.
So let's compare New York to Hugo Chavez, and hand out some Econ 101 grades:
New York State: We need to "prevent rent profiteering."
Hugo Chavez: We need companies to "make money in a rational way, that they don’t rob the people".
Econ 101 Grades: F for both! The way to prevent "profiteering" and "robbing" is to make sure markets are competitive in the first place.
New York State: Regulations are "a necessary response to a housing shortage".
Hugo Chavez: "Companies cause shortages on purpose, holding products off the market to push up prices." So again the price ceiling is a response to the shortage.
Econ 101 Grades: Double F again! Price ceilings aren't the remedy for shortages, they're the cause.
Total GPA 0.00, for both. I'm concerned that neither Hugo Chavez or the New York State Legislature will be allowed to graduate....
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