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The Pros and Cons of Price Controls

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A version of this article also appeared in the South China Morning Post's Young Post on Thursday, May 12. http://yp.scmp.com/news/features/article/103436/pros-and-cons-price-controls

How much should an ice cream cost? Is there a justified level of profit, and when does profit turn into consumers being cheated? Should governments try to protect people from high prices? Questions on fair pricing have been at the centre of economic policy discussions for a long time.

There is evidence to show that government price controls generally lead to economic dysfunction and the breakdown of effective markets. One of the most striking examples today is the crippling shortage of basic necessities in Venezuela. This is a result of the government’s attempt to manage retail prices and protect consumers from inflation.
Although most economists have long agreed that government price controls are not effective, there is still the question of how to ensure buyers are not exploited by unscrupulous sellers.

In economics, information asymmetry describes situations in which one party in a transaction has more and better information that the other. The result is an imbalance of power, with one side having a greater ability to influence the terms of trade. In retail, this could be represented by a poorly-educated individual who is charged excessive prices at a corner shop because he is unaware of how much a particular item should actually cost.

With such situations in mind, India introduced a maximum retail price (MRP) in 1990, before the country opened up its economy. The MRP, which includes taxes, is printed on all packaged goods sold in India. An item’s MRP is decided by its manufacturer, and it is against the law to sell at a price above the MRP. However, many do choose to sell below the maximum price. India remains the only country with a legally permitted MRP, although many nations have recommended retail prices.

One of the key criticisms of price controls is that they harm consumers by creating shortages of goods. What commonly occurs is that producers, faced with a government-approved maximum price, are unable to make reasonable profits, so they scale back production. The result is less choice for consumers and lower-quality goods in the market as manufacturers try to cut costs.

The MRP tries to avoid this problem by giving manufacturers the right to set prices. Retailers may not sell at any price above the MRP, but the manufacturer can choose to set the ceiling as high as they wish.

Unfortunately, this causes problems for sellers in rural areas. They have to pay more for transportation but cannot increase their prices. As a result, it’s consumers in less accessible areas who are affected. They have fewer options to choose from, and even if they are willing to pay a higher price for an item, it may not be available at their local shop.

There is also a strong case to be made that information asymmetries will eventually be eliminated by the market. Unscrupulous merchants, the theory predicts, will soon find themselves out of business as people realise they are getting a bad deal. In competitive markets, and with the help of the internet, it is easy to compare prices to get the best deal.

But the problem is that in many rural areas, there may not be enough sellers to choose from, so it’s hard to rely on the competitiveness of the market. Additionally, the role of the internet as a price regulator is not realistic in areas with limited internet access. It is ultimately the people who have few choices and few sources of information whom the MRP seeks to protect.

There will no doubt be times when policies such as the MRP benefit vulnerable consumers. Economic history suggests, however, that the greatest benefit to the greatest number of people occurs when free market prevails. Fairness may best be achieved through fewer barriers to competition, not through government directives.

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