It is with the recent imposition of price controls over essential food commodities such as white sugar, wheat flour, canned fish, big onion and recently hoppers that some economic issues have emerged in the market. Simple economic principles say that government intervention into the market through price controls, especially maximum and minimum price levels, will result in market imbalances, opening up a can of worms.
It was recently reported that the essential food items importers raised their voice concerning the grievances they face due to the imposed maximum price level, entitling them a very thin profit margin of one percent to 1.5 percent. Even if the price controls are removed in the open economy and the government lets the market forces determine the price in the market, there are some situations where the government is compelled to get involved in price controlling efforts, especially with the sole objective of ensuring people’s well-being.
Let me explain the positives and negatives of price control with simple economic principles.
Prices set freely by the market play a crucial role in the economy. Even though the price is normally regulated by the demand and supply in the market, the government can impose either the minimum price or maximum price, which is considered the price control method.
Reasons
In finding reasons as to why a government decides to impose a minimum price or maximum price, it has to be noted that the minimum price is imposed to protect the producers against lower prices and the maximum price is imposed to protect the consumers against higher prices. Politically-motivated governments may impose maximum price on essential goods so as to make voters happy, keeping their popularity, due to the less living cost.
On the other hand, because of a bumper harvest in the season, supply goes up, making prices too low. Here, as farmers have to incur losses by selling their crops at very low prices, a minimum price is imposed to protect the farmers, bringing the price of the good from the market price to a higher price level, which of course provides producers with fair returns. However, it is expected to give a pride of place to the maximum price by discussing with examples in Sri Lankan context.
Maximum price
Because suppliers under the maximum price policy are not allowed to sell products at higher prices, exceeding the imposed price level, some needy consumers, who have less purchasing power, are provided with an equal opportunity of getting their needs met. The government, during the festive season, decides to impose maximum prices on essential food items, so that even the poor can have an equal access to food commodities.
Furthermore, if firms have a monopoly power in the market, they can charge higher prices to consumers, especially higher than the marginal cost of production and higher than in a competitive market. For instance, once a maximum price is imposed on domestic gas cylinders to protect the consumers against the skyrocketing prices, the suppliers have to lower their profit margin but are able to survive in the market. Nevertheless, if the supply is very inelastic, the maximum price will not reduce the supply of the good; therefore, there will be no fall in the quantity supplied.
When a shortage of food items arises, the supply goes down, making prices too high. The price has to be controlled at a certain level by imposing maximum price regulations as a short-term strategy. Goods have to be imported to mitigate the shortage, preventing prices from increasing as a long-term measure.
Outcomes
Even though a maximum price is imposed to ensure that the particular goods and services are sold at an affordable rate, it results in lots of problems hurting producers as well as consumers. Moreover, price controls can reduce quality, create black markets and stimulate costly rationing.
Long queues can be seen in response to the shortage created by the higher demand and lower supply. As soon as the price is controlled in favour of consumers, it means low price, the demand for the particular goods and services goes up unprecedentedly. Because suppliers become demotivated with lower prices, they tend to hide the prevailing stocks of goods and to stop supplying goods in the long run.
Accordingly, the ulterior motive is to sell goods at higher prices at the black market, which means an illegal market, where the market price is higher than the legally-imposed price. You can easily remember some cases where a shortage of food items occurred in the history, mainly because of price controls.
It is when their cost is higher than the maximum price that the suppliers struggle for supplying goods at the imposed price. They cannot be prevented from finding alternatives of coping with market imbalances. That is why, low-quality goods are supplied to the market, making their production cost low, so that they are able to adjust to the imposed price.
For instance, with recently imposed maximum price for hoppers, there is a higher possibility of producing low-quality hoppers. However, what happens in the long run is that because some suppliers are reluctant to lower the quality and get their goodwill tarnished, they may decide to temporarily suspend producing the particular commodity.
Consequently, the market becomes less profitable for firms, resulting in less investment and innovation. If subsidies are given to suppliers, so that their production cost is low, they will be able to survive and go with the imposed price. However, it is so costly for a government. On the other hand, once suppliers stop producing goods in bulk, they lose economies of scale, bringing profits down.
Accordingly, the government must let the market forces determine the price without creating market imbalances.
(Amila Muthukutti holds a Bachelor’s degree in Economics from the University of Colombo and can be reached at [email protected])
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