Many will remember the national shortage of basic household products in early 2020 in the wake of the emergence of Covid-19. The near-empty store shelves that prevented many Americans from obtaining goods such as meat and bread, bottled drinking water, toilet paper, and disinfectant supplies (depicted below) are the real-world consequence of what is known in economic theory as a price ceiling: a set point above which prices are not allowed to exceed for a given unit of supply.
Empty store shelf of supermarket in Midwest American suburb, 17 March 2020
A price ceiling imposes an artificial price set below market equilibrium which, all things equal, creates a shortage. Rather than a shortage in the sense that there is less absolute supply in existence, the shortage is the direct result of a price phenomenon. Said another way, the ratio of goods to people did not change. Rather, demand for these items surged and left store shelves empty on a largely “first come, first serve” basis as individuals hoarded essential supplies. This shortage is illustrated in the shaded portion of the graphic below:
Shortages of disinfectant continued for the better part of six months, despite the additional productive capacity afforded by numerous alcoholic beverage companies, among others, which shifted entire business operations to producing disinfectant supplies. Yet, demand at existing (non-free-market-adjusted) prices still outstripped the increased amount of disinfectant. Even as the physical supply of disinfectant increased, excess demand resulted in an artificial shortage in the absence of corrective pricing.
As is the case with any price control, self-imposed or mandated, it is critical to understand a free-market, price-coordinated economy uses prices as a mechanism to convey the value society places on goods and services. If common goods such as disinfectant and basic food staples had been allowed to rise in price, commensurate with demand, a shortage (at least for non-medical supplies) would not have occurred. Rather, the higher prices would have directed the available resources to their most efficient uses. Instead, a significant amount of hoarding occurred, preventing such goods from being used for more efficient uses.
When considered purely in theory, compassion for the poor, sick, or otherwise lacking is often placed over the “arbitrary” cost of inefficiency that price ceilings invariably create. Advocates for price ceilings inherently, and often proudly, accept this cost under the altruistic belief that goods and services are cheaper for individuals who want to buy them which otherwise could not. Some go so far as to accuse advocates of the free market as lacking empathy and “just want[ing] people to suffer”. In reality, the shortage in the graphic above represents the actual cost of inefficiency in the economy in the form of individuals and businesses unable to obtain disinfectant supplies (schools, restaurants, nursing homes, hospitals, at-risk persons with Covid-19 comorbidities) or basic food staples to feed their families.
Consider the accepted cost of price ceilings in the following scenario:
Several tornadoes rip through north Texas, devastating the area and leaving thousands homeless. This reduces the supply of physical accommodations (homes, hotel rooms, &c.) available to house families, though demand for housing is unchanged. Under a free market system, prices would rise since available housing is now more valuable to society in the impacted area; this commensurately reduces demand and brings the market into equilibrium (supply = demand). Under an imposed price ceiling, housing remains artificially cheap and price increases are prevented from conveying the increased value of housing to society.
A family of four left homeless by this disaster, who would otherwise only purchase one hotel room at the higher market price, can now afford the luxury of purchasing two rooms because of the price ceiling on hotel room rates. The consequence of this inefficiency is of no concern to the family with two rooms but is felt by the next family of four whose home has been destroyed and now has no place to sleep due to an artificial, but very real, shortage of hotel rooms at existing prices.
Though the most efficient use of the hotel rooms would be to house both families, the price of the economic inefficiency accepted by society under a price ceiling is paid in the form of a family without shelter that could have otherwise obtained it.
The imposition of price ceilings is a prime example of legislating via desired goals rather than incentives created. Incentives created by price ceilings include, but are not limited to:
Reduced supply.
Price ceilings make new investment into a particular industry unattractive to investors unable to recoup investments due to artificially low prices. Additionally, existing supply will either deteriorate in quality (described below) or stop being supplied altogether as such industries becomes unprofitable.
Healthcare exemplifies this case well. Lower payments from the government Medicaid program to healthcare providers is the primary reason why healthcare providers accept Medicaid patients at lower rates than patients with private insurance, ~85-94% compared to ~67-71% (Source 1, Source 2), respectively. The primary reason government Medicare patient acceptance is relatively comparable to privately insured patients is because Medicare payments to healthcare providers are often higher than Medicaid. In fact, healthcare providers in states where Medicaid pays higher rates are more willing to accept Medicaid patients.
Higher costs.
The net result of the above is to raise costs for patients with private insurance (increased insurance premiums) to make up for the loss of revenue from the provision of price-controlled services.
Higher costs also exist in highly rent controlled (rent control being a price ceiling) cities such as New York City and San Francisco where builders intentionally supply only the housing luxurious enough to be exempted from rent-control policies. The added luxury incurs significant cost to tenants that may prefer less luxury for less cost. Unfortunately, there is no incentive to provide this type of rental housing.
Decreased quality of goods and services.
In cases where a business continues to operate under price ceilings, such as property managers overseeing rent-controlled properties, the owner is often unable to earn enough profit to maintain quality over time and has no incentive to.
The New York Times (NYT) acknowledged this issue in a piece detailing the dilapidated housing conditions of New York City in the mid-1980s. In it, the NYT comments on rental units needing repair that tenants subject to rent control objected to paying for via higher rents. Furthermore, since New York City at the time had a near-record backlog of applicants for rental units, business owners were not incentivized to provide quality housing for tenants since they could cover the loss of a revenue from one dissatisfied tenant with revenue from a backlogged applicant. Under rent control, the feedback loop that forces businesses to maintain quality are nonexistent since the owner is not concerned about losing customers.
Simply put, businesses will reduce the quality of goods where possible to match the price being paid for them to avoid losing money.
Prioritization of wants over needs.
The most common argument in favor of price ceilings is they allow less wealthy individuals to buy goods and services that might otherwise be prohibitively expensive.
Consider an individual living alone making $65,000 who may desire to increase living space and buy a house. While this individual may have plenty of space in an apartment, his demand effectively drives up the price on homes for other people that need the extra space more, such as a couple with small children. Under an imposed price ceiling, the single individual would be able to purchase a home (assuming a bid is accepted) and decrease the availability of homes available for what could be argued better purposes.
It is often argued price ceilings prevent greedy businesses from “gouging” the poor. However, few if any would consider the single person above making $65,000/yr to be poor, even though higher free market prices of homes forced the individual out of the higher-priced market when forced to prioritize needs (food, internet, &c.) over wants (more space). Furthermore, the argument of “gouging the poor” conflicts with the fact that prices are not set arbitrarily by businesses without regard to what customers are willing to pay. Following this logic, a “greedy” business like Apple could make significantly more profit by pricing its iPhones at $1,000,000; obviously, Apple understands that doing this would cost them valuable customers.
Creation of black markets.
Shortages often result in a black market for that good or service: alcohol under prohibition, human organ trafficking, and guns to name a few. Black markets are created to meet societal demand in an industry that would otherwise be unprofitable and undersupplied under a price ceiling. As a result, prices are not only higher than mandated prices, but higher than the market price in order to pay for the added risk of conducting business illegally.
The ramifications of these policies can be predictably identified through a fundamental understanding of basic economics and a cursory analysis of empirical data. Until market forces can correct to equilibrium, the scarce resources subject to price ceilings will continue to be directed away from society’s most valued, efficient uses. These are the real costs of price ceilings.
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