Price Ceilings

“I am today ordering a freeze on all prices and wages throughout the United States.” In August of 1971, in an attempt to control inflation, President Richard Nixon simply declared that price increases were now illegal. Soon after Nixon's declaration, the situation in many markets started to look like this. The market equilibrium price was above the current price, but it was illegal to raise prices. Prices were hitting the ceiling, the maximum price allowed by law. With a price ceiling, buyers are unable to signal their increased demand by bidding prices up. And suppliers in turn have no incentive to increase the quantity supplied because they can't raise the price.

The result is a shortage, shortage. The quantity demanded exceeds the quantity supplied. For example, in the 1970s, price ceilings on gasoline meant that it was common to have no gas at the gas station.

However, the story doesn't end there. More people want to buy gasoline than there was gasoline available. So who gets the gasoline? Rather than compete for gasoline by bidding up the price, buyers now competed by waiting in longer and longer lines, in effect bidding up their time. In the '70s, people would wait for hours at the gas station to fill up. So while the monetary price of gasoline doesn't rise, the price paid in people's time did increase. Moreover, when buyers pay for gasoline with money, the seller gets the money. When buyers pay for gasoline in time, the seller doesn't get the time. The time just gets wasted.

Do you recall from the previous videos how the price system coordinates the actions of thousands of people all over the world in order to deliver flowers? Well, with price controls in place, the economy became dis-coordinated. Shortages of steel meant that construction workers had to be sent home and new building construction delayed. Factories and offices had to close when shortages meant they couldn't operate. And when they closed the firms relying on them had to close too.

In perhaps the most ironic case, a shortage of steel drilling equipment made it difficult to drill for oil even as the United States was undergoing the worst energy crisis in its history. And other odd things started to happen. In a market economy, when it gets cold on the east coast and the demand for heating oil increases, entrepreneurs ship oil from where it has low value, here in sunny California, and ship it to where it has high value in cold New Hampshire. Buy low, sell high. With price controls in place, high-value consumers of heating oil couldn't bid up the price, and so there was no incentive for entrepreneurs to bring oil to where it was in greatest demand.

As a result, in the harsh winter of 1972 to 1973, people were freezing on the east coast even as people elsewhere in the United States had enough oil to heat their swimming pools. And then, the chickens started to drown. A price ceiling had been imposed on the price of chickens, but not on the price of feed. Farmers realized that at the controlled price, they would actually lose money if they fed their chicks to fatten them up and bring them to the market. So the farmers drowned millions of baby chicks. “Thanks, price controls.” The list of strange, unintended consequences like these go on and on.

In the next few videos, we'll dive deeper into price ceilings, the five types of effects they cause, and how to analyze these using supply and demand.