Price Controls and Market Distortions

Overview

• Price controls affect the signaling and incentive functions of prices.
• They cause market distortions, misallocation, and shortages.

Laws Against Price Gouging

• Common after natural disasters (e.g., hurricanes).
• Governments often ban unconscionable price increases.
• Demand for essential goods spikes (ice, food, generators, gasoline).

Market Dynamics Pre- and Post-Disaster

• Before Hurricane:
  • Demand curve D0, supply curve, equilibrium at quantity Q0 and price P0.
• After Hurricane:
  • Demand increases to D1.
  • In a free market, prices increase (to P1), signaling suppliers to bring in more goods.
  • Equilibrium quantity would shift to Q1.

Impact of Price Controls

• Price Ceiling: Government sets ceiling at P0.
  • Quantity demanded increases to Q2.
  • Suppliers supply only Q0 due to inability to cover costs.
  • Results in a shortage: Q2 - Q0.
  • Misallocation occurs: Generators may not reach those with highest willingness to pay.

Consequences of Price Ceilings

• Overconsumption and under-provision lead to shortages.
• Deadweight loss.
• Misallocation of resources.

Examples of Price Control Issues

• Transportation: On busy nights (e.g., Saturday), unadjusted prices lead to ride shortages.
  • Increased demand with fixed prices results in cab shortages.
  • Misallocation: those less in need might get rides, while others willing to pay more cannot.
• Free Parking:
  • Price ceiling of zero leads to high demand.
  • People pay with their time searching for spots.
  • Misallocation: those with lesser need might get spots over those with higher willingness to pay.

Conclusion

• Price controls are a blunt instrument causing misallocation, long lines, and black markets.
• They prevent productive exchanges at market-determined prices.
• Often used because they appear to be an easy solution to managing high prices.
• May reflect a lack of understanding or disregard for microeconomic principles by policymakers.