Many economists oppose price controlsespecially those following a disaster or other unforeseen event (often referred to as an “anti-dumping rule”). However, UMASS-Amherst economist Isabella Weber disagrees. He writes on Twitter: “One of the problems with [the supply and demand diagram] that it lacks an essential element: time. When it comes to emergency price increases, that is a big problem.” This tweet elicited many responses from different economists, most pointing to the supply and demand model. it does consider time: the x-axis is properly labeled “quantity per unit of time.” (My late, great PhD professor, Walter Williams, would deduct points from anyone who wrote the x-axis as just a value). Furthermore, both supply and demand are elastic over time.
These objections are valid, but I think they miss the claim Weber is making and the big, economic mistake he is making. Weber argues that price controls do not have negative weight-loss effects when the supply of the good is adjusted and the time line for it to be unadjusted is long. Let’s analyze his claim first on its merits and then from a rich economic lens.
Weber approaches this problem from the perspective of Marshallian welfare economics where market performance is judged by whether or not the net surplus (benefits from trade to the producer and benefits from trade to the consumer) is maximized. Calculating these benefits from trade is very simple: for the consumer, it is simply the difference between what the consumer is not. you are determined paying for each unit used and what they are must pay for each unit used. For the producer, the profits of trade are the difference between the price the seller receives for each good sold and what he is willing to sell for each good sold. The net surplus (total gains from trade) is thus consumer surplus (consumers’ gains from trade) and producer surplus (producers’ gains from trade).
Two very important things to note: 1) how much extra money is made in the market depends on the exchange rate in the market. If the exchange rate falls, the total price will fall (and vice versa) 2) how the surplus is distributed between consumers and producers depends on the price. In general, a higher price means a lower consumer price and more producer surplus (all things being equal).
From the strict, social and economic perspective of Marshall, Weber’s claim is correct. If supply is fixed (ie, perfectly inelastic) and there is no time to increase supply or get an elastic curve, then the law of increasing prices will not cause weight loss. Since price is fixed, setting a lower price simply shifts the benefits of trade from the producer to the consumer. The total market surplus does not change; there is no weight loss as the price in the market does not change.
However, from a broader, richer economic perspective, when we think about how people behave when faced with different choices, his point is wrong. Price controls will still lead to shortages as the quantity demanded exceeds the quantity supplied. Although there is no fatal weight loss, the cost of that shortage is still high: queue, price collection, etc. Furthermore, since the price is kept artificially low and the supply curve is inelastic and/or inflated, the cost of the price ceiling persists longer than it would otherwise. These are real costs and, if you think about them, it shows that even with fixed supply, price controls make everyone worse off.
Therefore, by comparing these two states (price rises where the producer surplus is transferred to the consumer but the consumer and the producer bear the highest total costs in the long run, or prices rise, the consumer surplus is transferred to the producer, but these additional costs are not imposed), the price ceiling still has undesirable effects, especially after a disaster.
And there are many other possible objections as well. In a conversation with me on Facebook, retired Texas Tech economist Michael Giberson pointed out that there is no particular economic reason to favor consumers over producers in this (or any other) exchange. Another is that there is no reason to think that the distribution of goods to the consumer will be “fair”.
Moreover, as Kevin Corcoran recently reminded uswe want to avoid the one-stage thinking that pervades Weber’s claim. Price control legislation has long-lasting effects by changing suppliers’ incentives against disaster preparedness. Like economist Benjamin Zycher exhibitionswartime price controls discourage producers from hoarding for the war property during peacetime. The same is true of unsecured assets. Fundraising is expensive; it takes up storage space for goods that cannot be sold immediately. For firms to accumulate, they need to have high expectations of future prices. If they know they cannot charge higher prices in the future, the costs of stockpiling will be higher than the benefits. Firms will keep fewer goods on hand, so that when disaster strikes, fewer goods will be available as a result. The best time to end price controls is before a crisis. Second best time now.
Overall, Isabella Weber’s tweet is statistically correct but economically incorrect. It is internally consistent and logical, but it lacks economy. We must always look beyond the model to the simulated reality.
Jon Murphy is an assistant professor of economics at Nicholls State University.
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