Prices: Why do they matter? | Chapter 8
Published October 3, 2022
Who should decide the price of something? Some look to the government to set laws and regulations that establish prices, but it doesn’t generally pay off for consumers. Laws that limit how much businesses may charge—price ceilings—give businesses less of a reason to meet demand and give consumers fewer reasons to conserve. The results are lower quality goods in short supply. Is there a better way to keep prices low and support prosperity for all?
Why don’t price controls work?
Price controls (or price ceilings) restrict sellers, forcing them to keep prices low for high-demand products and services. When prices are not allowed to rise, the excess demand for the good or service leads to a shortage of supply.
There are plenty of examples of price controls leading to negative outcomes in a variety of markets. One common example is that of rent control. Rent control is a government-mandated control on rent prices within a specific jurisdiction. Rent control typically doesn’t reduce rents but rather controls their rise. Rent control increases demand for rent-controlled units but discourages landlords from entering or expanding the rental market, which decreases the supply of rental housing.
To learn more about this common example of price controls, watch our video on the consequences of rent control.
When you imagine a prosperous future, it naturally includes the ability to make your own choices. You want to live on the moon? Go for it! But remember, each choice comes with costs, too.
Unfortunately, your future moon chateau won’t be cheap—rent, water, Lunar Landowners’ Association fees—everything has a price. And you’d probably prefer these prices to be low. Especially for the essentials.
Even better, you’d like someone else to pay for them. Like the government. After all, you need water. You pay taxes. Why doesn’t the government just use your taxes—and everyone else’s—to pay for the water?
That might not work out as well as you think. Some places have tried, but government officials struggle to figure out the right amount to supply and how to do it cheaply. In countries where governments control the economy, that control often results in shortages, restrictions, and low-quality goods.
Also, you’re on the moon. It’s hard to get water on the moon. And the people back on the home planet don’t really want their taxes to foot the bill for your expensive water deliveries.
Maybe there’s another way the government can help you out. If you’re buying your water from a business, the government could set limits on how much the business is allowed to charge.
Those limits are called price ceilings, and there are lots of different kinds. Rent control laws restrict how much landlords can increase your rent in a given year. And regulations around price gouging keep businesses from unreasonably jacking up their prices when buyers are vulnerable, like during a natural disaster or a pandemic—or when the supply shuttle is late for its lunar landing.
Politicians love price ceilings. They get to brag to voters that they kept prices low without actually having to spend any taxpayer money. Everybody wins, right? Not exactly.
With a price ceiling, the price of something doesn’t reflect how scarce it is and how much it really costs to produce. When prices don’t reflect scarcity, consumers are more likely to waste resources.
So, go ahead and wash that lunar rover every day. Experiment with water balloons in low gravity. And that crater in the backyard? That’s a private swimming pool now. Or an ice skating rink, when you’re on the dark side.
But, while price ceilings lead to overuse, they also fail to give businesses good reasons to produce enough. If you’re using more water, but the water provider isn’t making more money, they’re not going to supply sufficient water to meet your needs. That’s how shortages are created.
A strict price ceiling on water might mean the rover isn’t the only thing that doesn’t get a shower.
In other cases, price ceilings lead businesses to cut costs by reducing quality. Um, gross.
Even back on the home planet, price ceilings can have big impacts. In big cities, rent control laws have led to housing shortages—the exact opposite of their goal. And, since they know they can’t increase rent, landlords don’t always feel the need to maintain their properties in good condition or make upgrades.
Rent regulations can also cause mismatches in housing. When the rent is kept low, older couples may keep their large homes even after their kids have moved out. Big families, meanwhile, find themselves squeezed into one-bedroom apartments, since larger affordable housing options are occupied by those empty nesters.
So, is there a better way to keep prices low? Fortunately, yes. It’s competition. High prices may seem unfair, but they encourage new businesses to open and compete for customers. Competition ultimately drives prices down, since customers like low prices and high quality. The result? An abundance of low-priced, high-quality goods.
Prices matter. And having the government artificially change and restrict prices does not benefit everyone in the long run. Instead, when prices no longer reflect scarcity, we get overconsumption, shortages, and whatever that is.
As they’ll say on the moon one day, there’s no such thing as free water.