Why are Price Controls bad?

The price of a good reflects its relative scarcity and the relative preferences for that good. Why is water relatively cheaper than diamonds? Because its less scarce. Why are Hondas more expensive than Hyundais? Because people prefer the former.

Price controls control prices but that can’t hope to control those underlying factors. If you fix the price of diamonds low, it doesn’t make them less scarce. Making Hyundais more expensive (by reducing the price of Hondas, say) won’t make people like them.

What does the history of thousands of years of price controls tell us?

The first thing undermined or destroyed is self-rationing. When you pay the full price of going to a doctor, you go there when you have a broken leg but not when you have the sniffles or a minor skin rash. When the government makes health care “affordable,” you go there for sniffles and a minor skin rash.

The underlying reality has not changed, however. The doctor’s time is still limited, and the time that you take up with your sniffles or skin rash is time that somebody else with a broken leg — or perhaps cancer — has to wait to get an appointment.

Government-run health care systems in countries around the world have longer waits — sometimes months — to get medical attention. In other words, the rationing goes on, but more haphazardly, because prices do not force people to ration themselves according to the seriousness of their problem.

It is the same story when housing prices are controlled by government. Rent control has allowed some people to take up more housing space than they would if they had to pay the full price that reflects other people’s demand for housing.

The net result, whether in New York or San Francisco or elsewhere, is a lot of apartments with just one person living in each, and lots of families who cannot find a vacant place to move into. Housing shortages have resulted from rent control in cities around the world.

Housing shortages mean that some people are forced to live far from their jobs and commute, and some become homeless on the street. Homelessness tends to be greater in cities with rent control — New York and San Francisco again being classic examples.

Economists have long been saying that there is no free lunch but politicians get elected by promising free lunches. Controlling prices creates the illusion of free lunches.

Thomas Sowell

6 thoughts on “Why are Price Controls bad?”

  1. De Beers. Fiji Water. In consumer markets, and to a lesser extent in B2B markets, increased price can indeed lead to increased demand.

    Do you have figures on health care consumption rates comparing regions with socialized health care with cash-only systems? Can this data be overlaid against figures like life expectancy, infant mortality rates, death from preventable/curable diseases? Also – are private practices prohibited in countries with socialized medicine?

    Actually, your argument seems like an argument against non-catastrophic insurance coverage. Private health insurance in this country violates many of the principles of good economics that you have defined: low co-payments conceal costs, waiting lists for specialist consults can run to weeks or even months, and our facilities are chronically understaffed (your sniffles vs. cancer argument). Are there examples of any working cash-only systems?

    I won’t draw so much of a line around rent control, though I will say that New York and San Francisco are probably much more tolerant of the homeless than many cities, and San Francisco’s mild climate actively attracts many homeless.

    Politicians have always gotten elected by promising free lunches. Bread and circuses, anyone?

  2. “increased price can indeed lead to increased demand”

    Careful there buddy… You wouldn’t want to go upending one of the most cherished laws of economics, the law of demand.

    Price can be a signal of quality. Fiji water is more expensive, which signals its quality as better water (i.e. in taste or more likely in the image it provides the drinker). Demand isn’t slopping up for “water”, rather there’s demand for high quality water and then there’s demand for low quality water.

    The Law of Demand (bold, italics, underline, exclamation mark… its a LAW buddy!) always holds. When price goes up, demand goes down. Always! Got it!

    (I’ve always found argument by screaming to be the best technique of persuasion.)

  3. So, the Law of Demand says if you lower the price a consumer has to pay for health care, then he’ll demand more. When you subsidize health care (via employer tax incentives), you’re just reducing the price to the consumer.

    I know too little about health care to safely go beyond this econ 101 analysis.

    I’ve seen arguments for subsidized catastrophic insurance plans.

    “Private health insurance in this country violates many of the principles of good economics that you have defined”

    This is true but health insurance is subsidized and its hard to parse out what inefficiencies that’s causing.

    RE rent control and homelessness: rent control causes higher demand for apartments in the city. At the same time, there’s no incentive to build new apartment buildings. In the market for apartments in a particular city, we call demand greater than supply “homelessness.”

    Here’s a pretty recent empirical study on homelessness. Let me know if you can’t get access.

    “In particular, the results suggest that a simple economic model of the tough choices faced by households and individuals in the extreme lower tail of the income distribution goes a long way towards explaining the problem. Most importantly, our findings suggest that homelessness may be combated by modest supply policies combined with housing assistance directed to those for whom housing
    costs consume a large share of their low incomes.”

  4. That’s an interesting answer regarding luxury goods – that the value derives from the social value of the purchase rather than any intrinsic value in the goods. I just get a little cynical in cases where, for example, an accidental markup on an item causes sales to skyrocket (fashion items), or people refuse to buy certain goods unless they are intentionally crippled at the end of production (budget CPUs).

    I’d argue that health care is a funny case. Need and demand can vary wildly between individuals, even if the cost to each is identical. It’s not a buffet line. A pregnant woman is generally going to consume far more services than a dock worker, regardless of price.

    My interpretation of your overall argument is that price controls are bad because they can’t react quickly enough to meet the needs of the suppliers. Fixed too low, they starve the suppliers out, and quality of service drops. Fixed too high, and they discourage the market competition that’s supposed to lead to improvements in quality and efficiency (look at the graft in the Katrina zone).

    I’m not really arguing in favor of price controls anyway. Why not pick a cleaner example though, like energy prices?

  5. Health care because I anticapate it will be a big issue in the next election. Socializing medicine is just fancy way of saying you’re instituting price controls.

    As far as I’m concerned, “need” plus budget determine “demand”. Price controls don’t help the pregnant lady get more health care than the dock worker. In fact, as I clumsily argue over at Gavin’s, price controls actually prevent the pregnant lady from getting health care to some extent.

  6. This is actually Gavin’s comment which should be over on his site (don’t ask):

    I’ve sicked Yoko on the very concrete question, “How much did the hospital bill (the government/cloud?) for my $17 hospital visit? She seemed rather intrigued in finding out the answer, though it may take her some time. She’s gotta figure out where to ask, first.

    Second comment I thought I’d drop off is this. I’ve oft heard about the waiting line in the Canadian and European socialized medical systems, but I’ve never heard a peep about it here in Japan. (Someone get Grace in here to tell stories!) Hmm… more research to do. Also, as Scott points out…

    …aww crap I just forgot what I was gonna say.

    OK how about this? I would have gladly paid twice – three times what that IV cost me. Further evidence under the economic model that the system is broken I suppose, but it’s probably safe to say that there are retirees for whom that $17 is about the max they can afford.

Comments are closed.