Price Controls – Everything Can Be Measured In Anything by Donald J. Boudreaux, Foundation For Economic Education

The magic of market prices

In The Road to SerfdomF.A. Hayek makes an elaborate and important point that is summarized nicely, I think, by this key observation by David Friedman (recently mentioned in a comment on this post by Walter Clark):

Economists are often accused of believing that everything — health, happiness, life itself — can be measured in money. What we actually believe is even odder. We believe that everything can be measured in anything.

Among the many benefits of the price system, unfettered by government-imposed price controls, is that market-set prices allow each buyer to pay for the things he buys with the particular goods or services that he values the least, while simultaneously allowing each seller of those things to be paid, in exchange for those things, in the particular goods and services that she values the most. Monetary exchange at market-determined prices, in effect, eliminates all need for barter.

An example: monetary exchange at market prices permits Joe to pay for his lunch with (say) a ticket to the movies, while Jane, the seller of that lunch, is paid for it with (say) a glass of lovely dry riesling to be enjoyed tomorrow evening. What Joe pays for his lunch is not only that which Joe minds least giving up (among the multitude of goods and services that he can spend his money on), it is also not the same as that which Jane receives.

Jane receives from Joe not a ticket to the movies but, instead, a glass of dry riesling. This is so because the market-determined price of the lunch (say, $12) is the same as the price of that glass of lovely dry riesling. Monetary exchange at market prices enables happy outcomes such as this one.

But government-imposed price controls, be they ceilings or floors, unavoidably make the outcomes less happy for many of the parties to exchanges. Price controls at best encourage barter; as explained below, they often encourage something even worse: wasteful expenditures of resources. And the stricter are such controls — that is, the lower is the mandated price ceiling and the higher is the mandated price floor — the greater is the proportion of barter (or wasteful expenditures) to efficient monetary exchange. And as every student who has completed a good Principles of Economics class knows, when human beings must rely upon barter, many exchanges that otherwise would have occurred do not, in fact, occur.

Suppose, for example, that the market price of propane in the DC metro area immediately after a monster blizzard is $5 per pound (roughly five times its price prior to the blizzard being forecast to strike the DC area). Further suppose that to “protect” consumers, all the area governments impose a price ceiling on propane of $1 per pound.

Because both the demand for propane is made higher by the blizzard (many people are now without power in their homes), and the supply is made lower (many roads are now impassible or, if passable, treacherous), if sellers can be paid for propane after the blizzard no more than they were paid before, there will be a shortage of propane in the DC area.

But buyers want propane more desperately now than they did before the blizzard. So, having a very low chance of getting it at $1 per pound, buyers start spending directly real resources to increase their chances of getting propane. Most commonly, buyers start spending their time: they wait in lines (queues).

This expenditure of time (and incurrence of aggravation and inconvenience) is a real cost to buyers, many of whom would prefer to avoid this form of real expenditure by paying a higher money price for propane. For these buyers, if a higher, market-clearing monetary price were allowed, they would pay for the propane with, say, six-packs of beer or new pairs of jeans instead of with their time.

The reason is that, for these buyers, the utility to them of the beer or jeans that they sacrifice for the higher-priced propane is less than the utility these buyers would get from time spent in some way other than waiting in line for a chance to buy propane at $1 per pound.

Of course, the value of the time that buyers spend waiting in line is not captured by propane sellers. That value is completely wasted. It goes for naught. It’s an expense to buyers without being a benefit to sellers. Therefore, the queuing of buyers does nothing to increase sellers’ willingness to supply more propane. The matter would obviously be different if buyers were not prevented by government from competing to buy propane by spending more money for each pound of propane.

The buyer who offers the propane seller $5 per pound gets propane by sacrificing things that the buyer minds least to sacrifice — sacrificing, say, a new pair of jeans rather than a few hours of his time spent in a queue. In addition, and perhaps even more importantly, what the buyer sacrifices when he’s not prevented from paying in full for propane using money is value that is transferred to the seller. That value incentives the seller to work harder at getting propane to buyers. And then, being paid for propane in money — money that the buyer would have otherwise spent on a pair of jeans — the seller uses the money to buy, say, a new toy for her toddler. Jeans are paid for the propane while a new toy for a toddler is received for it. (Also, do not forget, more propane is available to more buyers.)

Let’s return to the situation in which DC-area governments, motivated (we can here assume) simply by sheer economic ignorance, impose a price ceiling on propane of $1 per pound. We saw above that queuing as a means of enhancing each buyer’s prospects of getting propane is a complete waste of resources from society’s point of view because time spent queuing produces no expansion in economic output.

We saw also that, while waiting in a queue is obviously the best strategy, given the shortage of propane, for each potential buyer who queues, that buyer is likely to prefer other means of competing to buy propane — say, by being able to sacrifice the new pair of jeans rather than his time. The price control, however, makes such an exchange difficult, for the very same reasons that barter is a difficult means of buying and selling goods and services generally.

But suppose that our buyer is singularly lucky. He happens to know that the propane seller wants a certain pair of jeans. So the buyer in need of propane dashes from his home first to the department store to buy that pair of jeans. This buyer pays, say, $125 for the jeans. He then drives to the propane-seller’s place of business, knocks on the back door, and offers to give the seller the jeans in exchange for 20 pounds of propane. The seller accepts the buyer’s offer. The deal gets done.

(Pop quiz for serious students of economics: Why is the buyer willing to pay for 20 pounds of propane an amount in money that is greater — here, by a total of $25 — than the buyer would have had to pay if this market were not saddled with a price ceiling?)

More realistically, such barter exchanges don’t involve each of the parties having (or having easy access to) the other party’s ideal good or service for exchange. Imperfect matches are the norm.

For example, the propane seller, seeing the long queue of buyers hoping to get propane, might send out a message asking if any of the wannabe buyers near the end of the line is willing to spend, say, 90 minutes helping the propane seller clear her home’s driveway of snow. This deal is not ideal for the propane seller: she’d prefer to receive in exchange for the propane a new pair of jeans rather than an hour and a half worth of help clearing her driveway of snow. Nor is this deal ideal for the buyer: he’d prefer to get the propane by sacrificing a $125 restaurant meal for himself and his family to giving up an hour and a half of his time helping a stranger clear away snow.

But, for both parties, the deal is better than the alternative: the seller gets something worth more to her than whatever she would purchase with the $20 that she would have received from selling the 20 pounds of propane at the ceilinged price for money, while the buyer increases, to 100 percent, his chances of getting 20 pound of propane in exchange for whatever additional time (if any) he must spend helping to clear a driveway of snow instead of spending that time waiting in a queue.

Or consider the minimum wage.

An employer with a stupid bias against gay people chooses — with a minimum-wage in place — among the several applicants for his one job opening an obviously heterosexual person. But in the absence of a minimum-wage diktat, a gay job applicant had the option of offering to work at a wage lower than the wage necessary to hire the heterosexual worker. And had such an offer been made by the gay job applicant, the bigoted employer might well have accepted the offer.

The reason is that the $X that the employer saves by employing the gay worker can be spent by the employer in ways that the employer regards as best — say, on a new car, on a vacation to California, or on new living-room furniture for his home. That is, the employer in this example has ways of spending $X that are preferable to him than spending $X indulging his preference for having only heterosexual employees.

And absent the minimum wage, he’ll spend his $X in those ways. In contrast, with the minimum wage he is prevented from saving $X when employing workers, so he engages in what we might call “subsidized barter”: unable to spend $X in ways other than employing low-skilled workers (given his decision to employ one such worker), he satisfies while on the job his consumption preference to be out of the presence of gay people.

As the David Friedman quote above suggests, freedom to spend money at prices set on markets (rather than controlled by government) allows the value to an employer of exercising his bigotry against gay people to be measured in vacations to California or new living-room furniture, just as it allows the value of propane to be measured in pairs of jeans and time spent at home with the family, and for the value to one person of lunch today to be measured in the value to another person of a glass of lovely dry riesling tomorrow.

Well-meaning advocates of price controls do not understand this reality.

A version of “Price Controls – Everything Can Be Measured In Anything” first appeared at Cafe Hayek.

The Road to Serfdom Price Controls

The Road to Serfdom: Text and Documents by F. A. Hayek