Government price controls violate the principles of a market economy, but are essential for reducing social inequality and stabilizing the economy. This process can also lead to problems such as black market formation and excess supply.
Even in capitalist market economies, where price determination is left to free market forces, governments sometimes make efforts to artificially set and maintain market prices for certain goods. This direct government intervention in price formation to fulfill a particular objective is known as price control. Price controls may seem contrary to the principles of a market economy, but they are necessary in certain situations. For example, when markets fail to function normally due to social turmoil or natural disasters, price controls are an essential means of stabilizing the economy. Whereas taxation is an indirect regulation that allows the government to influence demand or supply to change prices and volumes based on the normal functioning of market mechanisms, price controls are direct regulations that allow the government to influence prices and volumes while preventing market mechanisms from functioning. These controls play an important role in alleviating economic imbalances and reducing the economic burden on certain groups of people.
The most common forms of price controls are price ceilings and price floors. Another reason why governments introduce price controls is to achieve social justice. If the market is allowed to operate freely, social inequalities such as income disparities are likely to widen, which can lead to social unrest. When a shortage of a commodity causes prices to skyrocket, the government sets an upper limit on prices to protect consumers, a system known as a price cap, and the price set is called the maximum price. The peak price is lower than the equilibrium price because it is the price set when the equilibrium price formed in the market by supply and demand is too high. The equilibrium price is the price at which the quantity demanded and the quantity supplied in the market match. The amount of demand and supply under this equilibrium price is called the equilibrium volume. However, this is why there is a shortage in the market and consumers can’t buy as much of the product as they want. The greater the difference between the peak price and the equilibrium price, the greater the shortage. As a result, this shortage can lead to inequitable distribution among consumers, which can be a source of social conflict.
This creates the problem of a black market, as consumers are willing to pay more than the highest price to acquire the goods. Since black markets operate outside the formal economic system, they also have a negative impact on government tax revenues. This can lead to another economic imbalance. On the other hand, the opposite of a maximum price system is a minimum price system, where the government sets a minimum price and prevents prices from falling below it. The purpose of setting a minimum price is to protect the interests of producers, such as in agricultural price support systems. Minimum prices play an important role in stabilizing farmers’ livelihoods, especially in commodities with volatile prices like agricultural products. However, because the minimum price is set higher than the equilibrium price that would otherwise occur in the market, it creates a problem of excess supply. This excess supply creates economic inefficiencies and can lead to unnecessary waste of resources if governments fail to address it.
Artificial allocation methods can be used to solve the problems that arise under the maximum price regime, including first-come, first-served and rationing. The first-come, first-served method is a system that sells goods to consumers in order until they run out, while the rationing system is a system that distributes ration cards to each consumer and allows them to buy goods according to their ration cards. Although these rationing systems aim to distribute goods equitably, in practice, they can lead to dissatisfaction as consumers do not receive the amount of goods they need. In practice, a combination of first-come, first-served and rationing is used because the supply diminishes over time. The reason for the diminishing supply is that the price is artificially tied to a low level, which causes some producers to stop producing the commodity over time. When producers are not fairly compensated by the market, they are more likely to abandon the product and switch to other economic activities.
There are two ways to solve the problem of minimum pricing. The first is to increase demand, and the second is to decrease supply. Examples of the first option include the government using a stockpile fund to buy up all the excess supply of a commodity, or the government giving free vouchers to the poor that can be redeemed for excess supply. While these demand stimulus policies can alleviate the problem of excess supply in the short term, they can strain government finances in the long term. An example of the second option is encouraging producers of goods to reduce their output, while only guaranteeing them the value of the goods that would have been produced by the idled capacity. Supply reduction policies can increase economic efficiency, but producers may be unhappy due to uncertainty about the future, which could lead to reduced production.
