EC103-Topic #1: Price Controls, Supply and Demand

Since Hugo Chavez became president of Venezuela, he has attempted to revert the economy to one controlled by the state. By fixing prices (typically the prices that suppliers receive) the president believes that he can overcome the laws of supply and demand. There are many stories regarding Venezuelan price controls that show the government may not have as much control as they might like. Try to find another story regarding price controls outside of Venezuela (and outside of this link) to display this point. You might also want to think about the law of ‘unintended consequences’ that plays a large role in this.

Questions you might try to answer:

  • Why does Chavez, or any other government official attempt to put price controls into place? Who are they trying to protect?
  • Describe the impact of ‘nationalization’ on the prospect of private investment in an industry. You could think specifically about foreign direct investment.
  • When governments attempt to control prices, what impact does this have on the economy? What impact do price controls have on the ‘standard of living’ of different classes in the short run? What impact do price controls have on the ‘standard of living’ of different classes in the long run?

I would like your statements to be as subjective as possible, or in jargon terms, positive and not normative in nature. Also, remember, I want you to keep your descriptions short, basic, and related to classroom content. Read other students comments before posting, and please leave your name with your posting.

13 thoughts on “EC103-Topic #1: Price Controls, Supply and Demand”

  1. In searching for other stories where governments are trying to impose price control but suffering from a lack of control, I found an article in the NY Times, Pinched by Price Controls, Power Plants in China Scale Back by Keith Bradshire from January 24, 2008. China has been suffering from a series of consequences due to several problems recently directly and indirectly related to price controls. The government has been imposing price controls in recent months in an effort to combat inflation. Some of the problems stem from the cut backs in fuel production because of price controls. With price controls, refiners could not sell diesel fuel for more than the cost of the crude oil needed to make it resulting in a shortage. Trucks stopped delivering coal to power plants because of a fuel shortage and as a result, there is now a shortage in electricity. The Chinese government has enforced a ration on electricity, which is forcing factories to shut down one or two days a week. I believe this plays into the law of unintended circumstances.A little too late, the government of China created subsidies for refineries but now the snow-covered road are impassable and coal supplies are now “perilously low”. On top of the shortage of coal, the coal companies are also selling at increased prices due to increased demand and ignoring their legal responsibility to society to provide low cost to power company. (an other unintended consequence)One last centralized regulation issue… Low electricity tariffs have been set by the providences, which makes it even less profitable for oil-fired plants to operate due to the low cost of electricity. The government is ordering the plants to reopen and operate at a loss but many plants have not done so as of January 24th when this article was published. This is an example of how governments may not have as much control as they would like due to the fact that people may not be obeying the laws that are in place.

  2. While price controls may seem like a good strategy for overcoming supply and demand laws in Venezuela, if past history of such controls is any indication, the consequences for such controls may be bigger than President Chavez realizes. In 1979, the United States government set price controls for gasoline in response to the Iranian Revolution and OPEC oil embargo. However, by setting the price control below market level, suppliers had no economic incentive to increase gasoline production in response to increased demand, which then led to a shortage of gasoline. As a result, gas had to be rationed out. In addition, while people may have been paying less per gallon at the pump, the hours spent in line waiting to get gas meant taking valuable time away from other activities (such as time spent at work). An article, written in June of 2004 by David R. Henderson, estimates that with price controls on gas, the average consumer was paying about $0.80 per gallon, but spending an extra $0.30 per gallon in line and on lost wages waiting for gasoline. Without price controls he estimates that the average consumer would instead have been paying $1.00 per gallon, or $.010 less. It seems that price controls are likely to do little to help Chavez control the economy, and more likely to hurt its consumers.

  3. Through attempts to curb the milk shortage in Venezuela, Chavez’s price controls are likely to create even greater milk shortages. In my research, I came upon an article similar to the one Kristine mentioned. Strapped for resources, China is facing a coal shortage as well as high inflation. As a result there have been many blackouts and brownouts throughout the country, halting industrial production and creating dangerous conditions in the cold winter. In reaction to this China has recently capped utilities charges. According to David’s Lague’s article Blizzards and Coal Shortages Strain China’s Rail Network from The New York Times, analysts have reported that “without the incentive of adequate profits, power producers have been reluctant to increase output,” furthering China’s power crisis. This reluctance to produce necessary power is likely to transfer over to Chavez’s policy in Venezuela; with a reduction in the incentive to sell milk with capped prices, suppliers are likely to avoid selling milk to Venezuelan consumers. When the the Venezuelan milk shortage is considered in the context of the law of unintended consequences, it becomes apparent that as it becomes less profitable for milk products to be sold on the Venezuelan market people are likely to move to producing other things, such as beef. With regards to utilities, China made a similar move to Chavez’s international trade threat, halting coal exports for two months. However, there is little room for companies to get around this measure. Additionally, although prices on utilities may be capped for now in China, they will not necessarily remain that way. This gives power companies future opportunities for continuing their trade and incentive to weather a two month period without exports and a short period with capped prices.

  4. I found a New York Times article, “Anti-Inflation Curbs on Prices Create Havoc for Zimbabwe,” about price controls in Zimbabwe early last summer. The government there insisted that businesses cut prices of their merchandise in half or lower as an attempt to remedy Zimbabwe’s severe inflation, which made basic foods extremely expensive. Police and youth militia began going from business to business, threatening owners who refused to lower prices. Crowds of civilians followed militias to stores, buying almost everything in stock at the newly-lowered prices while militiamen were present to enforce it. Many shopkeepers were left with empty shelves and were unable to restock long thereafter. So, whatever effective “signaling” existed between supply and demand of that merchandise was severed when nearly all merchandise was simultaneously consumed. The immediate consequence was at least a significant delay in supply; all merchandise became very scarce long after stores were raided. In the long run, the article predicted that, instead of increasing production, manufacturers and shops would simply lay off workers or cease operation altogether- certainly an unintended consequence as well. In short, this government and policy also attempted more economic control than possible, and caused unintended ramifications as a result.

  5. I agree with Julia’s comment on price controls. When governments attempt to control price, they define a certain product at a certain price. The truth is that our economy changes constantly, and only through interaction between supply and demand, price of certain product will be on equilibrium level. The policy of price control will prevent market price on equilibrium level, and price control can do more harm than good to our economy. In order for governments to change price back to equilibrium level, it will have to take many political processes; thus, it becomes impossible for government price to reach equilibrium price; this also implies government price will be either too high or too low, and both cases can causes serious problems.When government sets price of a certain product above market price, it will causes an excess of supply, which can causes disruption in our economy because we have surplus in supply. For example, product A has a control price of 20 dollars, which is double price of what the product should worth in the market right now. However, as we all know that when price is too high, it discourages consumers from buying product A. As a result, this will cause an excess of supply. On the other hand, if government sets price below equilibrium level, it will causes shortage of supply. For example, in Jacob G. Homberger’s article “Price Controls Can Be Deadly,” he describes the shortage of gasoline in Iraq because of government-imposed price controls; price control causes long lines at gas station in Baghdad. The author says that low price causes supplies to be withheld from market and it also causes people to consumer more. In the article, Jacob also emphasizes that low gasoline price can lead to criminal activities. Jacob describes that many Iraqi entrepreneurs buy oil in gasoline station and then illegal selling gas in black-market for high price. Therefore, it is also a dangerous thing when the price is below market price. Jacob G. Homberger, “Price Controls Can Be Deadly”, Dec 12, 2003. Feb 02, 2008. M. Scott Morton, “Problems of Price Control”, Yale University, Feb 02, 2008.

  6. There are surely many real world examples of price controls. Aside from the Venezuelan example that was given to us; price controls seem to appear quite often in the world of pharmaceuticals. There were numerous specific examples from the pharmaceutical industry, but one written by a professor from the University of Connecticut was interesting, and it also referred to some unintended consequences. The article discusses how a price control on prescription drugs would lower the amount of money the company’s planned on generating. The author then claims that the same companies would no longer spend as much money on research and development, but would invest it in a more profitable market. An interesting argument is brought up in which scenario is better; easier access to the drugs, or the future advancement in the drugs as a whole. Supporters of price controls in the field are not purposely trying to limit the effectiveness of future prescription drugs; however it is an unintended consequence of their actions. This relates back to the initial case because as Chavez is trying to conserve the local agricultural economy, he could possibly limit future economic interest in the field.

  7. In searching for articles on price control, I found that the implementation of price controls is a very chancy, and sometimes not so successful business. A 2006 article from the Washington Post called ‘Dairy Industry Crushed Innovator Who Bested Price-Control System,’ speaks about price control on our own soil. The overwhelming majority of dairy farmers in the US work within a system that fixes prices so that the farmers have a guaranteed price to sell their milk at and so that prices for consumers are even. However there is more than one way to get around price-controls, which Hein Hettinga showed the farmers when he started selling his milk for 20 cents less per gallon to stores around southern California. When he cut out the middleman and did not work with the US government, his significant price drop began to create not only a large profit for himself, but turmoil in the dairy market nation-wide. By undercutting the rest of the farmers who blindly sold their milk at the fixed prices agreed upon with the government, Hettinga began to raise concerns about the overall effectiveness of the dairy programs in the US. Once investigated, it was found that the dairy programs filled with subsidies and protections for farmers actually raise the “retail price of milk,” cost the US taxpayers and consumers “at least $1.5 billion per year.” This example of programs put in place to help dairy farmers reveals that the use of price-control by the federal government may be more efficient in theory than in real life. Placing price-controls on an economy, as seen in Venezuela, is placing very rigid rules and regulations on a very fluid economy that can result in more bad than good—even for those not directly involved.

  8. In the article, it seems that the reason why Chavez is outraged is because he is seeing products from his country leaving to supply other nations. He wants to see his country generating support from its own recourses, which is totally understandable. This is why he was very frustrated when he saw that the company was not producing enough milk to be sold in the country and threatened to take over the farms. This reminds me of the Aplia homework we had due for tonight, where the U.S is cutting fabric trade because of the economy. The U.S wants to rely on its own recourses so we can help this country break out of the problem were having right now. The U.S doesn’t fabricate a lot of the products it sells on the open market. Only few car retailers such as Ford and Chevy are produced in the U.S but have no competition with international brands such as Toyota or Honda. This is why the government in many places is fixed on trying to have their people buy their own goods. Economies who are set on trading to support their country, such as China, would have great difficulty with this. China exports a great percentage of their goods, which makes them a great deal of money. Venezuela does import a great deal of the food that they consume, but Chavez is hoping to change this by turning the country into a “food producing power.”

  9. Through further research I was able to determine that foreign countries are not the only ones who have made mistakes through price controls. The United States itself has instated price controls that have back-fired against it. A prime example of this occurred in July of 2004. According to James Sterngold’s article, U.S. Price Controls Are Said to Worsen Power Shortage, the federal government forced the price controls of wholesale electricity throughout Western states in hopes of solving energy problems. Instead, these price controls worsened the power shortages of the states and bore more problems. This is a clear example of an unintended circumstance. The price control created an uncertainty among power plants as to if they would be able to be paid and therein created a shortage of productions. Power plants found themselves holding back up to 600 megawatts of power. These events, due to government-instated price controls, pushed California into a Stage 2 alert, also putting Las Vegas into a blackout.

  10. Thomas Sowell recalls a comparable incident in his Capitalism Magazine article entitled “An Ancient Fallacy: Price Controls” in which government intervened in a market and a shortage resulted. In 2002, Hawaii passed legislation which limited how high the price of gas could be in its state. As a result, oil refineries in Hawaii reduced the amount to be sold in Hawaii and instead sought to sell more oil to west coast states where no such price controls existed. The price control therefore caused refineries to reduce the amount of oil available to Hawaiian consumers. This example demonstrates that when a supplier is forced to take a lower price as a result of government intervention via price control, the quantity supplied in a market drops. Similarly, if Venezuelan milk producers are forced to accept a lower price by only selling domestically, they will reduce the amount of milk that they produce as a result. Chavez has falsely deduced that milk producers will continue to produce the same amount and will simply transfer the amount of milk they sell abroad to the domestic market. However, an unintended consequence will be that milk producers will instead produce less milk in response to comparatively lower domestic prices.

  11. Governments have been trying to set maximum or minimum prices as long recorded. Governments in the United States have fixed the price of gasoline, the rent on apartments in New York City, and the minimum wage, to mention a few. Price controls are normally justified as a way to help and protect consumers, however that reality is debatable.Prices are can be misunderstood in economics. Whenever prices are “too high”, a phrase commonly used to describe the price of medicines or of gasoline, many people think the answer is for the government to force those prices down.Controls prevent the price system from rationing the supply to those who demand it, a once a familiar scene in the controlled economies of Eastern Europe, the lineup was also popular during the 70s in the US when maximum prices were set for gasoline on a first come-first serve basis.Municipal transit used to be privately owned in many cities, until local politicians’ control of fares kept those fares too low to buy and maintain buses and trolleys, and replace them as they wore out. The costs were not reduced in the slightest by refusing to let the fares cover those costs. Likewise, Chavez noted that demand for milk has climbed abruptly in Venezuela while supply has not kept pace. Chavez’s government said it plans to loosen price controls on a variety of basic foods to help stem shortages. Thus, governments lack the amount of control they would like because, for example, by lowering the prices in the transit system, it lacked the maintenance to perform just as Chavez’s system has failed to deliver.

  12. Chavez attempts to counter domestic food shortages by threatening Venezuelan milk and chicken producers with an ultimatum. Forcing producers to stop exporting their goods to foreign countries, or face having their land expropriated by the government, is not the most encouraging way to stimulate economic activity in his nation. Chavez’s plan to lead Venezuela into “21st century socialism” does not allow a free market economy to exist, which may lead to the detriment of his nation in the long run. One example of a foreign country attempting to relax strict government regulation, in order to stimulate economic activity, was the socialist republic of China in 2005. The impact of the China’s decision allowed the “emergence of a powerful private sector” in the Chinese economy. Successful growth in China’s agricultural industry during the past two decades proved that “changes in government economic policy” have “progressively given greater rein to market forces”. The new legislation allowed “private individuals to own limited liability corporations” for the first time. These changes also stimulated growth in physical and human capital in China, and proved that reduced government legislation was key in stimulating new economic activity.I think that Chavez should learn from China’s economic model for 2005, and consider the benefits that decreased government regulation has on a national economy. Perhaps he could solve his country’s own domestic food shortage dilemma, while also stimulating more free market growth in Venezuela by reducing his stringent legislation.-Bejan,3343,en_2649_34111_35343687_1_1_1_1,00.html

  13. Similar to Taylor’s example, I too found an article on the price controls of pharmaceuticals. In 2001, 44.4% of China’s health expenditures were set for pharmaceuticals. As a top priority for policy intervention, the Chinese government adopted the control of drug retail prices. Using two Shandong hospitals, one provincial and one municipal, they began an in-depth examination of changes in prices, utilization, expenditures, and rationality of drugs; relating to cerebral infarction. Prescribed daily dose (PDD) was used for measuring drug utilization, and the contribution of price and utilization to changes in drug expenditures were decomposed. In the provincial hospital, drug expenditures per patient declined, this was chiefly derived from reduced utilization. In the municipal hospital however, drug expenditures per patient increased by 50.1%, chiefly due to greater drug utilization. From the top 15 drugs for treating cerebral infarction cases, after the reform, 19.5% and 46.5% of the expenditures from the provincial and municipal hospital, were used for drugs priced by the government.Utilization proved to be the determining factor for drug expenditures, while control of retail prices was proved to be ineffective in containing the drug expenditures. Similar to Chavez and the Venezuelan government, the Chinese government showed that they may not have as much control as they might like.

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