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Now, I want to give yet another quick caveat here: When economists discuss this phenomenon, you’ll often hear them talk about how prices cause goods and services to be allocated to their “best use” – which is a phrasing I don’t want to entirely endorse, because as mentioned earlier, “economically efficient” isn’t always perfectly equivalent to “socially optimal.” True, market pricing does cause goods and services to go to those who are willing to pay the most for them, but that isn’t automatically the same thing as saying that those customers are the ones who value those products the most; it may simply be that those customers are the ones who both want the products and have the most disposable income to spend on them. So for instance, if we imagine that there’s an emergency water shortage that causes the price of water to rise sharply, it might very well be the case that a billionaire who wants to wash their fancy car will be willing to pay more for a few gallons of water than a poor person who needs the water to avoid dehydration (but can barely afford it due to other expenses) – but that doesn’t mean that the billionaire therefore values the water more, or that selling the water to the billionaire represents its “best use;” it just means that the billionaire is the one who’s most capable of paying for what they want (and therefore doesn’t care as much about the cost). In other words, money and utility aren’t exactly the same thing – so we have to make sure that when we talk about goods and services being allocated to their “best use” or “most valued use,” we specify exactly which meaning we’re referring to. Wheelan gives another example of this:

I have stipulated correctly that if we raise the cost of driving gas guzzlers, then those who value them most [in the standard economic sense of the term] will continue to drive them. But our [economic] measure of how much we value something is how much we are willing to pay for it—and the rich can always pay more for something than everyone else. If the cost of driving an Explorer goes to $9 a gallon, then the people driving them might be hauling wine and cheese to beach parties on Nantucket while a contractor in Chicago who needs a pickup truck to haul lumber and bricks can no longer afford it. Who really “values” their vehicle more?

And this logic applies not only to the question of which customers are “best” to sell to, but also to the question of which products are “best” to be selling in the first place, as Michael Albert notes:

Market valuations of workers’ contributions [can often] diverge from an accurate measure of their true social contribution for [a simple reason:] In market systems we vote with our wallets. The market weighs people’s desires in accord with the income they muster behind their preferences. Therefore the value of contributions in the marketplace is determined not only by people’s relative needs and desires but by the distribution of income enabling actors to manifest those needs and desires. Thus, as measured in the marketplace the contribution of a plastic surgeon reconstructing noses in Hollywood will be greater than the value of the contribution of a family practitioner saving lives in a poor, rural county in Oklahoma—even though the family practitioner’s work is of much greater social benefit by any reasonable measure. The starlets have more money to express their desires for better looks than the farmers have to keep alive. If you pay more, it will cause what you pay for to be “valued” more highly. An inequitable distribution of income therefore will cause market valuations of producers’ outputs to diverge from accurate measures of those outputs’ implications for social well-being. Plastic surgery trumps saving malnourished children not because reversing malnourishment is less valuable then cosmetic surgery, but because Hollywood stars have more cash to express their preferences than do those who suffer starvation.

It seems clear enough that the definition of “value,” as defined by the market, doesn’t always map perfectly onto the social definition of “value.” In light of this, then, the next question we have to face is how best to reconcile the disparity – because without a doubt, there are better and worse ways to approach this issue. One approach we could take, for instance, might be to disregard the idea of market pricing altogether, and to try to have sellers artificially set prices at more “reasonable” levels, so that everyone could afford to buy what they needed, and more income could go to the producers who generated the most social value (as opposed to just the most market value). Under this kind of approach, we might imagine a seller of some socially-valuable product earning a higher-than-market price for their product as a reflection of its inherent goodness – or conversely, we might imagine the same seller lowering the price to below the market equilibrium level in order to make it more affordable to customers. Both outcomes are nice to think about, at least in theory (despite somewhat awkwardly contradicting each other). Unfortunately, though, equilibrium prices have a way of reasserting themselves in real life despite whatever attempts might be made to suppress them. As Jacob Falkovich writes:

In 1695 […] English philosopher John Locke published a very short essay called Venditio, concerning pricing and the ethics thereof. [In the essay, Locke explains] the Law of One Price in an open market, [which makes clear] that when you come to a city with many buyers and sellers, and they all sell and buy wheat from each other at 10S [i.e. 10 shillings], the only price you can sell (or buy) wheat at is 10S. Moved by some intuition of fairness you may want to sell it at last year’s price of 5S, but you can’t. Whoever buys it for 5S will immediately resell it for 10S to those who will actually consume it, you have simply given your profit away to an unproductive third party. You may want to sell your wheat for 20S because you’re greedy, but you can’t. No one will buy for 20S what they can get next door for 10S.

A single market will have the same price across it for a single good or service. What defines a single market is a group of buyers and sellers that are easily replaced by one another. That’s why the price of wheat in a shop down the street matters: the buyer can easily go there and get that price. That also why last year’s, or even yesterday’s, price in the same shop doesn’t matter: neither the buyer nor the seller can travel to yesterday and buy yesterday’s tomatoes at yesterday’s price. The price of tomatoes on Mars is more relevant to the tomato market in London than the price of tomatoes a week before; Mars is at least in principle available to trade tomatoes with.

Like Newton’s first law, which states that an object will not change its motion unless acted upon by a force, the Law of One Price is counterintuitive for the first 10 minutes of pondering it. At that point, it becomes so deeply obvious that one is shocked at how humans have lived for millennia without grasping it. Unfortunately, 10 minutes of thought are beyond the abilities of journalists and politicians to this very day.

The Guardian:

Burning Man tickets will be even more expensive this year thanks to a new Nevada entertainment tax that the state is requiring the festival to impose.

The price for the majority of tickets to the massive summer event in the Black Rock Desert, three hours north of Reno, has climbed from $390 to $424 for an individual ticket due to a 9% state tax that organizers have unsuccessfully tried to fight over the past month.

Quick, children, what’s the real price for Burning Man 2016 tickets, $390 or $424? The answer, of course, is that the only price of Burning Man tickets is exactly $840, that’s the price at which they are resold to the actual festival attendees. Burning Man organizers can keep a larger or smaller chunk of the $840 to themselves by raising or lowering the price, the state of Nevada can keep more or less of the $840 by changing the tax, but neither of them sets the price of $840.

Without nitpicking, let’s say that there are 70,000 tradable tickets available for Burning Man. The price of $840 is the only one at which exactly 70,000 people want to buy a ticket. Without changing the capacity or desirability of the festival, the only thing Burning Man organizers do by moving the price is deciding how much money to donate to Stub Hub and the resellers. They could have donated that money to poor attendees by giving some of them non-transferrable free admission (they do a little of it). They could have donated that money to charity. Instead, they simply donate 70,000 * $400 = $28,000,000 to ticket resellers for no good reason whatsoever. Hamilton on Broadway is donating $12,500,000 a year.

Well, okay then, you might be thinking – it might be futile for individual sellers to try and get around the true market price for their product; but what if, rather than leaving matters to individual sellers (and resellers), we just have the government mandate absolute price ceilings and price floors instead, so that no one can adjust the price beyond certain limits? Well, it’s true that this might resolve the reselling problem (at least if we pretend that black markets don’t exist at all) – but at the same time, it would also create a whole new set of problems of its own. Taylor explains some of the issues (including a few mentioned by Sowell earlier) before, luckily, offering some alternative approaches that might have fewer negative side effects:

If you have ever tried to rent an apartment in New York City or San Francisco, you know that the prices can be jaw-droppingly high. Demand for real estate is so strong that even unimpressive dwellings can command high rent. What should happen when the market-determined price seems unreasonably high to many people? On the flip side of the coin, some years, when conditions are exceptionally favorable, farmers grow so much that they receive very low prices for their crops. What should happen when the market-determined price seems unreasonably low to many people? Supply and demand are inevitable forces, but not all outcomes of supply and demand are desirable. Even the most enthusiastic free market economists don’t agree that nothing can or should ever be done about the outcomes of supply and demand. It is certainly possible for the government to intervene and affect the prices of what can or will be charged in particular markets. The question for price-control legislation is whether the methods used accomplish the desired goals, or might the result be counterproductive?

Disagreements about price and quantity in a market are impossible to avoid. Suppliers will always say if they just had a little more money, they could create new jobs, build new factories, hire more people. Demanders will always talk about the difficulties of trying to get by at their income level. Both sides will appeal to fairness. Businesses will say they just want a “fair” price—by which they mean a higher price. Individuals will talk about how the price of rent or electricity or gasoline is “unfair”—by which they mean the price should be lower. If a group is politically powerful enough, it can sometimes push a government into changing the law to enshrine its advantage.

When politicians are persuaded to enact a law to keep the price of a good low, they create a price ceiling—a maximum price for the product. Rent-control laws are one common example of a price ceiling. The political argument for rent control is that shelter is a need, not a want, and that the unregulated equilibrium point for housing is too high for a significant number of people to afford.

But a price ceiling doesn’t prevent the forces of supply and demand from working; in fact, these forces enable us to predict the consequences of the price ceiling. If you set a price ceiling lower than the equilibrium price would have been, people who are buying the good will be enthusiastic about that low price, but suppliers of the good are not going to be so enthusiastic. Quantity demanded will rise, but quantity supplied will fall. The result is a shortage.

Let’s look at rental housing again as an example. Rent control has led to housing shortages at many times and in many places, including the two hundred or so U.S. cities that have adopted rent-control laws at one time or another since World War II. One result is that in cities with strict rent-control laws, a consumer may not be able to find an apartment at the legal price; there are too many potential renters looking for too few apartments. Landlords, unable to meet their rising costs by raising rents, may skimp on maintenance; they also know that with demand so high, potential renters won’t be too fussy. As a result, the quality of rental housing diminishes. Owners might convert their rental apartments to condominiums, exiting the rental market altogether. Construction of new rental apartments will likely decline. The apartment owner may extract extra money from tenants through various ancillary fees, and from “deposits” that you pay when you move in but somehow don’t get back when you leave. Price ceilings also enable a gray market in which people who obtained the good cheaply resell the good to someone willing to pay more—in this case, one could sublet part or all of a rent-controlled apartment at a not-so-controlled rate. Finally, consumers who get into price-controlled apartments have a tendency to stay there for a longer time, thus preventing others—some of whom might have a greater need for a low-price apartment—from finding a rental.

The government can hold down prices, but in a free society, it can’t force sellers to produce more, and it is very, very hard to regulate all these possible ways of getting around a price ceiling.

Let’s consider the opposite case. When those who supply a good are a politically powerful force, that group can sometimes get the government to set a minimum price, or price floor. In the United States, for example, there are laws that have the effect of providing farmers who grow certain crops a guaranteed minimum price for their goods. The argument for price floors in agriculture is that the nation needs a stable and an expanding supply of food—we need to keep farmers in business—but the equilibrium price is sometimes just “too low,” so we need a law to guarantee the farmers a “fair price” (notice those value judgments). Whatever the political intent, the forces of supply and demand are unavoidable, and price floors have consequences.

If you set a price above equilibrium, suppliers will be delighted at the high price, and quantity supplied will be high. However, quantity demanded will be low. The result is a surplus: quantity supplied exceeds the quantity demanded. The government might act to avoid a surplus through quotas—limiting how much a producer is allowed to sell—or through buying and storing the excess product. In the United States, surplus agricultural products have historically sometimes been shipped to low-income countries as food aid.

The counterproductive effects of farm price floors go beyond the surpluses. The price of farmland will rise with price floors, because the products produced there are worth more. People who own the land benefit, but lots of farmers who rent their land will pay more, thus negating any benefit to them from the price floor on the crops they grow. Agricultural price floors may also have environmental consequences when they encourage the use of marginal land or potentially toxic chemicals to increase yields. The shipment of surplus product as food aid can be positive when it staves off a famine; however, food aid may also injure the farming economies of the recipient countries when their domestic farms can’t compete with an influx of free food aid.

Moreover, price regulation draws no distinction between who’s needy and who’s not. Price regulation changes the price for everyone. Some people who need help will receive it, but many who don’t need help will receive it, too.

What if the government simply tried to help everyone, with price floors for all producers and price ceilings for all consumers? Actually, that scenario is roughly how the Soviet Union tried to manage its economy. In the 1980s about a quarter of the central Soviet government’s budget was subsidies, because the government simultaneously subsidized high prices for producers and low prices for consumers. The Soviet Union suffered the costs of shortages, and surpluses, and black markets, and all the rest. As Soviet premier Nikita Khrushchev is reputed to have said, “Economics is not a subject that greatly respects one’s wishes.”

At about this point, some people get grumpy with economists and accuse them of having a concealed agenda. “You might say you’re open to different kinds of economic policies,” they grumble, “but it sure sounds like you’re dictating a policy, and that policy is noninterference. This whole riff about price floors and price ceilings and equilibrium is just an excuse for fatalism and inaction.”

But criticizing one set of policies doesn’t mean that no other policies are acceptable. Let’s start by considering some alternatives to rent control. One could give money directly to the poor by raising welfare payments, or by giving housing vouchers. This kind of demand-side help is more targeted than price controls, going straight to those who need it. On the supply side, a government could subsidize the construction of low-cost housing or adjust zoning laws to allow and encourage the construction of more low-cost housing. Either of these actions should result in a higher equilibrium quantity of affordable housing without causing shortages or surpluses.

What about agricultural subsidies? Imagine that the policy goal is to ensure a decent standard of living for farmers with small- and medium-size operations. Instead of implementing price floors, a government could subsidize buyers of food through food stamps, school lunch programs, and so forth. Encouraging demand should help farmers sell more of their product. On the supply side, the government could supplement the income of farmers whose farms are below a certain size, thus targeting the assistance to those in need. Both of these choices avoid the problems of accumulating surpluses of farm products at home or dumping the surpluses on developing nations abroad.

Ironically the political system tends to choose price floors and price ceilings precisely because they’re not especially good public policy tools. Whereas economists force themselves to acknowledge the trade-offs in any scenario, politicians often prefer to hide the costs of their policies. Price floors and ceilings look like policies with a zero cost because they don’t require a spending increase or a tax cut. Price controls sweep the costs under the rug.

Economists also believe in taking all the costs—not just the budgetary costs, but also the opportunity costs—into account. Rent control, for example, benefits some people because they get lower housing costs, but others suffer because they can’t find an apartment, and some construction businesses suffer because they can’t turn a profit. Similarly, when a government keeps crop prices high, the farmers producing those crops benefit, but poor and middle-class families face a higher price for basic food necessities such as milk or bread, and farmers in low-income countries may be living in dire poverty because food aid from heavily subsidized countries is pushing them out of the market. The waste from shortages and surpluses in these situations doesn’t show up on the government’s balance sheets as explicit taxes or subsidies, but it is a real cost nonetheless.

Economics as a subject is not hostile to the poor, nor does it require a vow of noninterference in a free market. Economists differ in their political beliefs, and so they will argue over whether certain kinds of interference are desirable policy. But where economists stand united, regardless of their political beliefs, is that they insist on acknowledging all the trade-offs of any policy.

This point about considering things in terms of costs, not just in terms of prices, can be a subtle one; but as Sowell emphasizes, it’s one that we ignore at our own peril:

Sometimes the rationale for removing particular things from the process of weighing costs against benefits is expressed in some such question as: “How can you put a price on art?”—or education, health, music, etc. The fundamental fallacy underlying this question is the belief that prices are simply “put” on things. So long as art, education, health, music, and thousands of other things all require time, effort, and raw material, the costs of these inputs are inherent. These costs do not go away because a law prevents them from being conveyed through prices in the marketplace. Ultimately, to society as a whole, costs are the other things that could have been produced with the same resources. Money flows and price movements are symptoms of that fact—and suppressing those symptoms will not change the underlying fact.

One reason for the popularity of price controls is a confusion between prices and costs. For example, politicians who say that they will “bring down the cost of medical care” almost invariably mean that they will bring down the prices paid for medical care. The actual costs of medical care—the years of training for doctors, the resources used in building and equipping hospitals, the hundreds of millions of dollars for years of research to develop a single new medication—are unlikely to decline in the slightest. Nor are these things even likely to be addressed by politicians. What politicians mean by bringing down the cost of medical care is reducing the price of medicines and reducing the fees charged by doctors or hospitals.

Once the distinction between prices and costs is recognized, then it is not very surprising that price controls have the negative consequences that they do, because price ceilings mean a refusal to pay the full costs. Those who supply housing, food, medications or innumerable other goods and services are unlikely to keep on supplying them in the same quantities and qualities when they cannot recover the costs that such quantities and qualities require. This may not become apparent immediately, which is why price controls are often popular, but the consequences are lasting and often become worse over time.

Housing does not disappear immediately when there is rent control but it deteriorates over time without being replaced by sufficient new housing as it wears out. Existing medicines do not necessarily vanish under price controls but new medicines to deal with cancer, AIDS, Alzheimer’s and numerous other afflictions are unlikely to continue to be developed at the same pace when the money to pay for the costs and risks of creating new medications is just not there any more. But all this takes time to unfold, and memories may be too short for most people to connect the bad consequences they experience to the popular policies they supported some years back.

Despite how obvious all this might seem, there are never-ending streams of political schemes designed to escape the realities being conveyed by prices—whether through direct price controls or by making this or that “affordable” with subsidies or by having the government itself supply various goods and services free, as a “right.” There may be more ill-conceived economic policies based on treating prices as just nuisances to get around than on any other single fallacy. What all these schemes have in common is that they exempt some things from the process of weighing costs and benefits against one another—a process essential to maximizing the benefits from scarce resources which have alternative uses.

He sums up:

A long-standing staple of political rhetoric has been the attempt to keep the prices of housing, medical care, or other goods and services “reasonable” or “affordable.” But to say that prices should be reasonable or affordable is to say that economic realities have to adjust to our budget, or to what we are willing to pay, because we are not going to adjust to the realities. Yet the amount of resources required to manufacture and transport the things we want are wholly independent of what we are willing or able to pay. It is completely unreasonable to expect reasonable prices. Price controls can of course be imposed by government but we have already seen […] what the consequences are. Subsidies can also be used to keep prices down, but that does not change the costs of producing goods and services in the slightest. It just means that part of those costs are paid in taxes.

Often related to the notion of reasonable or affordable prices is the idea of keeping “costs” down by various government policies. But prices are not costs. Prices are what pay for costs. Where the costs are not covered by the prices that are legally allowed to be charged, the supply of the goods or services simply tends to decline in quantity or quality, whether these goods are apartments, medicines, or other things.

The cost of medical care is not reduced in the slightest when the government imposes lower rates of pay for doctors or hospitals. There are still just as many resources required as before to build and equip a hospital or to train a medical student to become a doctor. Countries which impose lower prices on medical treatment have ended up with longer waiting lists to see doctors and less modern equipment in their hospitals.

Refusing to pay all the costs is not the same as lowering the costs. It usually leads to a reduction of either the quantity or the quality of the goods and services provided, or both.

Of course, none of this is to say that there aren’t in fact some cases in which the price being charged for a particular product actually does significantly exceed its cost of production (meaning that there would be some room to lower the price without causing shortages). The most obvious examples of this that come to mind are monopolies, which are able to make surplus profits for the simple reason that there is nowhere else for their customers to go in that particular product market. There are also cases of short-term “price gouging,” which tend to appear in the midst of natural disasters and other such crises (in the form of sharply rising prices on goods like water and gasoline) – and which, essentially, are also a kind of monopoly themselves, just more temporary in nature. Under these kinds of emergency conditions, it’s common to see price ceilings enforced more often than usual, for obvious reasons. However, as Falkovich points out, such emergency measures will often still run into the same issues that occur under non-emergency conditions – which is why he suggests that in such situations, the best solution might not necessarily be to try to artificially cap prices, but to instead allow the momentary opportunity for extra profit to act as an inducement to bring other sellers into the market as quickly as possible, so that their competition with each other will force prices back down to their equilibrium levels naturally:

When hurricane Sandy hit the tri-state area in 2012, many gas stations lost power and people at first were willing to pay $20 for a gallon of gas that cost $4 the week prior. This is such a novel and unusual situation… that John Locke described it with perfect precision 317 years prior:

To have a fuller view of this matter, let us suppose a merchant of Danzig sends two ships laden with corn, whereof the one puts into Dunkirk, where there is almost a famine for want of corn, and there he sells his wheat for 20S a bushel, whilst the other ship sells his at Ostend just by for 5S. Here it will be demanded whether it be not oppression and injustice to make such an advantage of their necessity at Dunkirk as to sell to them the same commodity at 20S per bushel which he sells for a quarter the price but twenty miles off? I answer no, because he sells at the market rate at the place where he is, but sells there no dearer to Thomas than he would to Richard. And if there he should sell for less than his corn would yield, he would only throw his profit into other men’s hands, who buying of him under the market rate would sell it again to others at the full rate it would yield. […]

Dunkirk is the market which the English merchant has carried his corn, and by reason of their necessity it proves a good one, and there he may sell his corn as it will yield at the market rate, for 20S per bushel.

Locke is correct that on a first order analysis, selling the corn (grain) at 5S in Ostend or 20S in Dunkirk are morally equivalent. If we also consider the effects of supply and demand, we can see that the ethical obligation is for the merchant to take his grain to Dunkirk, as his arrival there will help the neediest and immediately reduce wheat prices. The price of 20S is driven by the tiny supply of wheat available, even a single ship will increase that amount enough for the price to drop.

If New Jersey gas stations were allowed to sell gas at $20, the price would have stayed at that level for at most 3 or 4 hours. That’s how long it takes to fill up a tanker in Pennsylvania or Maryland and drive to Jersey.

Falkovich continues: “Who would be the suckers buying at $20 in the first few hours? Perhaps a doctor who must commute to a hospital where a single hour of her work is worth hundreds of dollars and the lives of patients.” Certainly, this would be a worthwhile use of $20. But for everyone else, for whom paying $20 per gallon wouldn’t be worthwhile, it would only be a short matter of time before they’d be able to get gasoline for a more affordable price – if, that is, conditions were such that competitors had the ability to freely enter the market and thereby drive prices down. And this is the crucial point: When these kinds of “price gouging” situations occur, it’s generally because some seller sees the opportunity to set up a temporary monopoly on an unusually scarce good – which means that in order to nip the situation in the bud, the best solution is often to simply enable competing producers to notice what’s going on and swoop into the market themselves, thereby alleviating the shortage while at the same time creating sufficient competition to cause prices to start dropping. If for some reason such competition isn’t possible, of course, then alternative approaches (like taxes, subsidies, etc.) can come into play. But it’s abundantly clear that whenever competition is possible in such situations, it ought to be encouraged – because after all, that simple phenomenon of competition is the key that makes the entire price mechanism work in the first place.

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