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Tom Woods: How price controls destroy markets

By | December 25th, 2010

After the parable of the ham sandwich, author Thomas E. Woods, Jr., Ph.D., a senior fellow at the Mises Institute, described to an audience at Colorado State University on Dec. 9 the system of voluntary rationing of goods that occurs in a free market pricing system:

“The price system itself - the price system that helps make that possible. O.K., these emerge spontaneously, there is no government price institution that says a loaf of bread is going to be ‘x’ dollars. Prices emerge voluntarily through the interaction of buyers and sellers. It’s like an auction. We know how price occurs at an auction. You’ve got one seller, people bid, the high bid wins. Alright, well just Imagine, in effect, just a whole bunch more sellers. And that kind of interaction is what yields you a price.

“Well, think about what happens if, let’s say, there’s some hurricane in Florida and a lot of people’s homes are destroyed. Notice what happens - the price of lumber immediately shoots up to reflect the fact that lumber supplies are suddenly very scarce in relation to the demand for it. Everybody needs lumber now, everybody’s got to rebuild houses. So that high price of lumber encourages us to stop putting lumber to trivial uses. Because right now we need it to build people’s houses again.”

As Woods argues, this immediate - and ultimately more important need - diminishes the use of lumber elsewhere, as in building a bird house several states away. The high price of lumber discourages the inefficient use of the good, keeping it where it is most needed, without the use of government force. Prices, not a government agency, direct the lumber to where it most needed and useful-Florida-and not a trivial or “marginal” use, as the price is too steep:

“But that’s a way in a non-coercive way you release lumber resources you might otherwise have used…voluntarily…you wait a little while until the prices come down. That’s a way of, in effect, rationing goods. But not rationing them through concentration camps and slavery, but through voluntary interaction.”

He also described the effects of price controls:

“Let’s suppose we interfere with the price system - we impose price controls…notice the difference here with the price control. Let’s say the price of lumber or whatever the good is - cannot, by law - go above this arbitrary level. Well, what’s going to happen? For one thing, there is now no incentive to consume less of the thing - because the price is still the same, so why would I feel like I would need to conserve it? If the price is allowed to go up, then it makes me want to conserve…There is no incentive to produce more. Whereas if the price goes up, the price of labor, price of whatever goes way up, then people will - I mean, if you’re on an island somewhere, people will come across in rafts if necessary to provide the services you need if the price is enough to give them a profit. But there’s no incentive to produce more because the price is still what it was, so it doesn’t call in, it doesn’t entire more people to furnish additional supplies of the good.”

Not only is the rationing voluntary, but the higher price encourages other producers, in this case lumber, to provide more of the good. If the price is kept arbitrarily low then, as Woods illustrates, there is no incentive to produce any more lumber. Allowing the price to rise naturally rations it at the end where it is used, and stirs production at the end where it enters the system. Lumber producers who were unable or unwilling to produce more of the good at $2 per board will now pick up the shortage at $3 per board. The profit incentive stirs the productive capacity-again, without government agencies or oversight.

But what happens when interference, such as governmental price controls or other processes are put into place, disrupting the natural rationing and production stimulated by the free market price system? Chaos, shortages, disruptions elsewhere in the economy, political implications, and some very bizarre side effects:

“And finally, there is no incentive to discontinue marginal uses of the good…And, in fact, as we saw in the 1970s oil crises, this problem, whereby urgent needs for the good were going unfulfilled because more trivia ones were, in fact, continuing to be pursued because no one had any incentive to stop…So, in other words, major uses are now unable to be enjoyed because these more trivial ones are still going on, because there’s no rationing, there’s no sensible kind of rationing that goes on as it would in a free market.”

Woods details oil rigs running out of fuel and the effect on food shipments as delivery companies stopped transport. The endless lines at gas stations are certainly familiar to anyone of a certain age.

Like other forms of price controls - rent control - the usual answer offered by those who installed the control in the first place is not to disengage from the interference, but to instead apply even more interference as a way of dealing with the lack of the “sensible kind of rationing” that is produced by the free market pricing system.

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