As you might expect, if prices are prevented from functioning in this way, markets will be less able to reach equilibrium. Therefore price controls (laws that “set” prices at certain levels) will be highly disruptive. There are two types of price control: ones that set prices above their equilibrium/market-clearing rate, and those that set prices below it. When prices are kept below their market-clearing rate, we call it a price “ceiling”. This is because policymakers are trying to prevent prices from rising upwards towards equilibrium. If prices are kept above their market-clearing rate, it’s a “floor”. Policymakers are trying to keep prices artificially high.
Here’s an excellent video on the role of prices in a free market economy:
Here’s a video on minimum wages:
There are several negative consequences of a minimum wage:
Here’s a video on rent control:
Some common consequences of rent control are as follows:
If you ever wondered how Monica and Rachel can afford such an amazing apartment, on such low salaries, now you know!
In 2020 Berlin adopted rent control and, as economists predicted, it didn’t work. As Andreas Kluth points out in that article:
In a shortage, regulating the price [of a good] only trades one expression of scarcity (high prices) for another (empty shelves).
Perhaps the key lesson of economics is that you cannot escape scarcity.
Another important example of a price control is anti-price gouging laws. These are designed to prevent prices from spiking following natural disasters and are intended to protect consumers from exploitation. It is typically seen as “unfair” if producers profit from an emergency. But consider the consequences of keeping prices at pre-emergency levels. Firstly, the new situation means that people will be willing to pay more than they did before. If the price remains constant this leads to an increase in consumer surplus and thus creates an incentive to buy more of the good. This hoarding will result in a shortage, and give an advantage to those who are first in line, at the expense of those who arrive later. Secondly, it will reduce the incentive for suppliers to respond. In an emergency, costs are likely to rise and if the price remains the same, profit will fall. Both of these factors will reduce the availability of goods. Encouraging non-essential purchases to be made and reducing the incentives for potential supplies are the opposite of what is needed to coordinate resources.
In December 2013 the BBC reported that bread prices had risen by 500% in parts of Syria. But this isn’t an example of the market failing. Expensive bread isn’t the cause of the problem. They are a consequence. And the fact that the BBC used this data point as evidence for the breakdown of social coordination in Syria demonstrates the usefulness of high bread prices. Price spikes are signs that the market is working. They are an important signal.
Uber prices tripled during the London Underground strike of 2015. This was predictably unpopular as people compared fares to before the strike but conditions had changed.
What would have happened if Uber’s prices remained constant?
As Peter Spence argued, “the result would be a mess: thousands of Uber users would spend ages on the phone struggling to hail cars. Simply put, there wouldn’t be enough to go around”. Instead of allocating rides first-come-first-served, Uber allocated them based on willingness to pay. Since those who a have a more urgent need for a taxi will be willing to pay more, cars will go to those who need them the most.
Notice how the price signal works on both sides of the market.
Uber is the classic example of a firm that has used dynamic pricing as part of their business model.