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

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