Why Congress Should Oppose Price Controls
A review of the economics behind “price-capping” energy
Prices play a crucial role in a market economy and history has shown that any attempt to artificially manipulate prices has disastrous effects. Prices send signals to producers and consumers about the preferences of consumers and the supply of resources.
In the case of energy, oil can be used in numerous ways (heating, lubrication, powering vehicles, generating electricity, etc.). Prices help to guide producers and consumers to the most efficient use of oil – simple as that.
If the demand for gasoline increases, the price increases and the supply will increase, resulting in a new equilibrium. When this happens, the supply for another oil derivative that is in lower demand will necessarily decrease. This system ensures that resources are not being wasted with surpluses and that consumers are able to buy the resources they need without worrying about shortages.
When the supply of an oil derivative runs low, the price increases, sending signals to consumers to either limit their consumption or shift their consumption to a lower priced alternative.
To borrow an example from Thomas Sowell in Basic Economics: A Citizen’s Guide to the Economy lets consider flashlights during a hurricane. A small costal town is hit by a hurricane, shutting off the power and temporarily blocking movement of goods in and out of the town. The local hardware store has a fixed supply of flashlights which under normal conditions would sell for say $2. Because of the power failure the demand for flashlights has increased, so the hardware store will increase its price to $4 per flashlight.
At this new, higher price, people will buy fewer flashlights, maybe only one per family rather than one per person. Some would also buy candles or glow sticks or borrow flashlights from others if they did not want to pay $4 for a flashlight. This allows more people who need flashlights the ability to buy flashlights. Once the power is restored to the town the demand for flashlights would decrease, and when the roads reopen the supply of flashlights would increase, bringing the price for flashlights back down. If the hardware store does not lower its price, the natural existence of free competition will force it to do so or lose its’ customers.
Price controls simply do not exist in a rational market. When this irregular form of forced economic control is introduced by governments, they disrupt the spontaneous order of the market and cause either surpluses or shortages.
A cap and trade system imposed on carbon dioxide gas (the by-product of economic production and basic transportation) would increase costs for producers of fossil fuel based energy and would limit the supply of fossil fuel based energy – thus leading to higher prices. The price increases are not a result of natural market forces. The actual supply of fuel is not lower, and the actual cost of production is not changed (except in terms of the new tax).
These arbitrary changes would cause prices to increase without allowing the market a chance to naturally adjust and shift resources to an alternative.
Currently, a proposed “solution” to these increased prices is to cap the price of energy. Capping the price of energy will cause shortages. In a free market, if supply drops but demand remains the same (or supply remains the same and demand increases), the price increases, sending signals to consumers to buy less and self ration, as in the example above. If prices are not able to increase, however, consumers will continue to buy at the same rate without any signals to slow or shift their consumption. Unchanged consumption with decreased supply will inevitably lead to shortages. This decline in product will lead to shortages and government imposed rationing.
This time in the flashlight example, there is no hurricane, but the government decides that flashlights are bad for the environment and decides that the hardware store has to buy permits for $2 per flashlight. This increases the cost of flashlights for the hardware store which forces them to increase the price per flashlight from $2 to $4.
The government decides that it isn’t fair for people who can’t afford $4 for flashlights and passes a law capping the price of flashlights to $3. The demand for flashlights is relatively unchanged because the $1 increase is not enough for most people to change their consumption. The store, however, is unable to recoup its costs on the flashlights at $3 and stops carrying as many flashlights.
The supply of flashlights has decreased while the demand remains unchanged. Now people who need a flashlight can not get a flashlight at any price. In order for everyone to get a flashlight, the government has to establish quotas and rationing to limit the number of flashlights each person can have. Eventually the hardware store owner decides he is losing too much money on flashlights and decides to stop carrying them. Now no one can get a flashlight no matter how much they need it or are willing to pay.
The same thing can happen with energy.
It happened in the 1970s with price controls on gasoline. It happened in Germany after World War I and II. And it was a major factor in the Great Depression when first President Hoover initiated price and wage controls and then President Roosevelt continued them.
History and economics both prove that price controls always lead to either shortages or surpluses.
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This brief was authored by Todd Hollenbeck. For more information, contact Federal Affairs Manager Brian M Johnson at [email protected].
Americans for Tax Reform (ATR) is a non-partisan coalition of taxpayers and taxpayer groups who oppose all federal, state and local tax increases. For more information or to arrange an interview, please contact John Kartch at (202) 785-0266 or at [email protected].