Introduction
A lot has been said about open economies but the fact is that their existence is only in theory. It is common knowledge that all countries in the world have some entry restrictions in their markets. With this in mind, open economies are described as those countries whose policies allow production and pricing to be determined by the forces of supply and demand.
The aforementioned restrictions are, therefore, in the form of policies that countries develop in a bid to accelerate economic growth. One of such policies is price control in which a government gives price floors and/or ceilings for products, rent, wages, etc. This paper is an in-depth investigation of the effect of price controls like rent control and minimum wage on the efficiency of an economy.
Importance of price controls
Price controls are a very important part of any market. They play very important roles in protection of consumers against exploitation by producers and retailers. Therefore, despite the shortcomings of setting price ceilings and price floors, they play an important role in markets (Sobel 41). For instance, in a case where investors habitually exploit consumers of rental services by continually increasing rent, the government may decide to set maximum rent figures in order to protect its citizenry from exploitation by the investors.
Another example is a case where employers give considerably low wages to their employees. In such a case, the government may intervene and set minimum wages for employees in order to give its citizens purchasing power and reduce the level of employee exploitation undertaken by employers.
These types of price control are, in a way, a catalyst of market efficiency. This is because if the government sets the minimum wage for employees, the employees will be given more purchasing power whereas the cost of production incurred by producers increases (Wells 83). This prompts producers to increase their scale of production in order to maximize their profits through an increase in sales volume. This makes goods to be sufficiently available in the market and it also makes consumers to demand the goods more.
This can be viewed to be an increase in the efficiency of the market since the market is able to sustain itself and both producers and consumers can rely on the market. On the other hand, in a market where rents are very high, there will be cases of houses going unoccupied since investors will be attracted by the high returns of the rent to invest in rental buildings (Thompson 1).
Therefore there will be a case of low demand and oversupply. If the government intervenes and sets maximum rent rates, investors will shy away from investing in rental buildings and thus the situation will be gradually reversed. This will actually increase the efficiency of the market for rental buildings since the supply will eventually balance with the demand.
Lastly, price controls are an effective tool of preventing and dealing with price inflations. As producers and retailers set their prices, they are aware of the potential intervention of the government in case the prices are unrealistic.
This makes the producers and retailers set prices that are acceptable to the consumers and that are able to bring the quantity supplied and the quantity demanded to an acceptable equilibrium (Welker 1). On the other hand, in the case, where unhealthy competition among producers and retailers lead to unrealistic prices, the government imposes prices that help in making the market realize an acceptable equilibrium.
How price controls contribute to inefficiency
In as much as price controls can be necessary in isolated cases, they lead to market inefficiency in the long run. This is because they generally have a distorting effect on market forces. They, therefore, tend to make the market operate under disequilibrium which adversely affects supply or demand. The price control is mostly meant to protect consumers from exploitation by producers and thus most price controls empower the consumer.
In some cases, the government may impose a price that is considerably below the equilibrium price (Rothbard 59). This affects market efficiency since more consumers will be able and willing to buy goods and/or services at the imposed price but the producers will not have sufficient motivation to offer enough goods and services to the consumers. The result will therefore be undersupply in a market with high demand for goods and services.
Another great disadvantage of price controls that affects market efficiency is the fact that price controls mostly leads to nourishment of black market (Helpman 17). This normally occurs in the case where the government imposes prices that make producers withdraw their products leading to undersupply in a market where products are highly demanded. This motivates traders who dabble in black market to scale up their operations since buyers are available and the traders have the opportunity to make supernormal profits.
This may make the market appear as if it is efficient while the fact is that the market is being sustained by the black market (Haislmaier 1). It also make the government reap minimal or no benefits from the imposition of the price controls since producers will withdraw and the black market, which does not pay taxes, will fill the gap left by the producers.
In a case where the government gives the maximum amount of rent that investors are supposed to collect from their tenants, investors will be discouraged from investing more on rental buildings whereas tenants will demand more apartments. This will lead to disequilibrium in the demand and supply of rental buildings.
Although the demand and supply are bound to reach an agreeable equilibrium with time, the status quo in the short run will make the market inefficient since it will be characterized by more demand and less supply of the rental buildings (Blinder 21). It can thus be concluded that the intervention of the government in such a case has counterproductive effects on the efficiency of the market since as much as it saves tenants from exploitation by landlords, it also discourages investment and it can, possibly, lead to shortage of houses.
In a case where the government imposes the minimum wages to be paid to workers, consumers will have more purchasing power which will, most likely, be counter acted by an increase in the average prices of goods. In this case, the government will have fuelled inflation of prices and consequently inflation of its currency (Koenig 25). This can be seen as an introduction of inefficiency in the country’s economy since the average prices of all goods and services in the economy will rise assuming that other factors will remain constant.
Imposition of a minimum wage may also have other negative effects on an economy like increasing of the cost of production of producers which may make them lay off some workers in order to maintain their previous profit margins.
This will, in turn, lead to the overworking of the workers who do not get laid off and thus the government will not have achieved its purpose of safeguarding workers from exploitation (Wirick 1). It can thus be concluded that minimum wage control by the government has counterproductive effects on the welfare of the workers who the government intends to protect.
Conclusion
As it has been evidenced in the discussion above, price controls have counteractive effects on markets and economies in which they are imposed. It has been stated that the government imposes price controls in the form of price floors and price ceilings for goods and services as well minimum and maximum wages and rent respectively. One of the main benefits of price controls is the fact that they are important tools in helping the government deal with the excesses of producers and retailers.
This way, the government is able to safeguard the consumers from exploitation by the stated parties. On the other hand, the most undoing characteristic of price controls as far as market efficiency is concerned is the fact that they lead to disequilibrium in the market which interferes with the normal market forces.
This affects the market adversely making the conflict between imposed prices and equilibrium prices have damaging effects on the markets. It, therefore, becomes difficult for the government to achieve its intended purpose since imposition of prices leads to a variety of significant reactions from the affected stakeholders.
Works Cited
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Helpman, E. Macroeconomic Effects of Price Controls: The Role of Market Structure. NBER Working Paper. 1989, pp. 11 – 23
Koenig, R. German Jobless Struggle On. Journal of Commerce. 1998, pp. 17 – 29.
Rothbard, M. Making Economic Sense. New York. Greenwood Publishing, 2008. Print.
Sobel, R. Private and Public Choice. New York. McMillan Publishers, 2008. Print.
Thompson, M. “Market Forces and Ceilings: A Classroom Experience”. 2001. Web.
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