Post 3: What Everybody Ought to Know about Economics
Should government impose price floors and ceilings?
In this series, I will be teaching from Economics, 3rd Edition by Professor Timothy Taylor. I am providing the link so that you can take the course yourself. I found it quite enjoyable.
In Lecture 4, Professor Taylor covers price floors and price ceilings. Both are the result of government intervention to help either suppliers (in the case of floors) or buyers (in the case of ceilings).
Taylor mentions Russia’s attempt to control prices but fails to mention President Nixon. Nixon tried wage and price controls to stop inflation. As Cato Institute put it:
By the time Nixon reimposed a temporary freeze in June 1973, Daniel Yergin and Joseph Stanislaw explain in The Commanding Heights: The Battle for the World Economy, it was obvious that price controls didn’t work: “Ranchers stopped shipping their cattle to the market, farmers drowned their chickens, and consumers emptied the shelves of supermarkets.”
Why don’t price floors and ceilings work? Economists don’t think in terms of moral judgement. They don’t ask if prices should be lower or higher. They look at the supply and demand curves to explain what is likely to happen.
If government imposes a price ceiling, like capping rent, buyers benefit. At the same time there is pressure on suppliers to produce less. When we look at the supply curve, supply goes up as price goes up. If price is capped below equilibrium, suppliers will supply less. They will also act in other ways, such as not providing maintenance. The lower price also increases demand. The demand curve shows that as price goes down demand goes up. Capping rent increases demand because the price is below equilibrium. We get people waiting in line to get an apartment.
If we have a price floor, like setting a price for commodities, price is above equilibrium. Farmers increase supply. Demand is reduced. What happens to the increased supply of commodities? Does the government buy it? Does it rot?
There are other activities that government can do other than price floors and ceilings. Poor can be given vouchers for food. Rent can be subsidized. However, from an economist’s view, it all goes back to supply and demand.
When I heard about Vice President Harris’ plan to give people money to buy homes, I thought of it in terms of supply and demand. My son is a general contractor. I asked him for his opinion. “If people are given $25,000 to buy a house, prices just went up $25,000.”
That might be a good thing. Increased prices should increase supply. However, supply is often being constrained. In my area, the cheap land is already gone. Cheap land is flat and easily buildable. Land on the hills might be cheaper to purchase, but costs much more to develop. Over two decades ago, my son bought a lot for about $1000. He spent three days on an excavator chiseling through rock to build a foundation for a house. That was just one example of increased cost.
Supply can also be constrained by government intervention. For example, regulations making homes more energy efficient increases the cost of production. The increased costs must result in increased prices or builders can’t afford to build. If buyers can’t afford to pay the increased costs, supply is constrained. That puts pressure on buyers to buy older homes that are not energy efficient. Prices of older homes go up.
It would seem that economists might constantly be in a position to say government should do nothing. However, as Taylor pointed out, there are things that can be done other than price ceilings and floors. We must think it through and monitor the results.