Chapter 15 of Shawn Ritenour’s Foundations of Economics discusses a government intervention into the economy so obviously flawed that even most mainstream economists condemn it. Moreover, even a large number of government officials seem to understand that it doesn’t work. Nevertheless, this intervention remains a seemingly permanent fixture in certain areas of the economy. I’m referring to price controls.
Compared to some of the topics dealt with in earlier chapters, price controls are fairly simple to understand once you grasp the laws of supply and demand. Governments normally don’t fix prices absolutely, but will sometimes establish for specified goods either price ceilings (maximum legal prices) or price floors (minimum legal prices). Ritenour deals with each of these in turn, distinguishing between “effective” and “ineffective” controls. An ineffective control is a price ceiling set above the market price or a price floor set below the market price. Ineffective controls have no practical economic effect; economic activity proceeds as it would have in the absence of any such controls.
“Effective” price controls, on the other hand, can have a significant economic impact. Ritenour discusses price ceilings first. When the price ceiling is below the price at which the market clears, there are too few sellers and too many would-be buyers at the ceiling. This produces a shortage which is more acute the more elastic the demand for that particular good. Producers who cannot profit at the price ceiling cease their operations, and new capital is diverted into other avenues of investment. The effects of this can be severe. Ritenour relates how his own father was thrown out of work when a price ceiling on beef led to a shutdown of the packing plant where he worked in the 1970s.
Shortages are not the only result of effective price ceilings. In an effort to make a positive return on investment, sellers of goods affected by a price ceiling may charge for ancillary activities such as customer service, or they may scrimp on quality, using inferior components in production. All these results are evident in the form of rent control, the effective price ceiling Ritenour highlights in this chapter. In cities with rent control, there are always shortages of apartments. Existing apartments are inefficiently allocated and are often maintained poorly. Capital goes into condominiums not subject to the controls. The policy of rent control fails in its attempt to ensure affordable housing for the poor.
Effective price floors lead to fewer buyers and an excess of too many would-be sellers. The result is a surplus of the controlled good or service at the floor. The more elastic the demand for the product, the more severe the surplus is. Potential buyers look for cheaper substitutes for the controlled product.
The form of price floor Ritenour focuses on is the minimum wage. Recall that wages are the price of labor. An effective minimum wage results in a surplus of labor at that price and thus more unemployment. Unskilled workers the value of whose labor is below the minimum wage are unable to break into the job market and are prevented from developing skills normally learned on the job that makes their services more valuable.
Employers will also use relatively inefficient methods to get below-minimum-wage tasks done. For example, when I delivered pizzas in college, I often got pulled away from necessary tasks in the back of the store to answer the telephone and was less productive as a result. The manager would have been willing to hire someone whose only job was to answer the phone, but the minimum wage ($4.25 at the time) was too high to pay someone just to stand by the phone except during the rush of orders around suppertime. The result was that the entire staff suffered a loss of productivity. Ritenour points out that not only labor, but also land and capital goods will often be allocated inefficiently as a result of minimum-wage laws.
This chapter also contains a short section summarizing Ludwig von Mises’s argument that the shortages and surpluses resulting from price controls inevitably lead to calls for further government interventions in the marketplace. Mises’s essay “Middle-of-the-Road Policy Leads to Socialism” develops this case effectively.
Ritenour concludes the chapter by writing that price controls are acts of aggression and are incompatible with a Christian ethic that proposes policy to achieve just ends by just means.
The most visible price floor in the United States is the minimum wage. The U.S. Congress passed a minimum wage law in 1938 and has raised its level and extended its coverage several times since then. The stated goal of the minimum wage is to help the poor. It will not directly affect most workers because they have wages that are above the minimum. Only those workers who are earning less than the minimum will be directly affected.