It doesn’t make sense to me. I used to be all like but then everything increases in price still Yada yada. But recently… why can’t we just lower the prices of petrol artificially. Why can’t we just lower housing prices by law?? Why can’t we erase inflation seeing as it’s completely made up anyway.
In: 0
Here’s something I posted recently on the problems with governments fixing prices.
Governments can and do sometimes fix the prices of goods. For example, in the UK there is a price cap on domestic energy. This kind of thing is more common in markets where competition is limited for some reason. However there are odd examples around the place – if I remember rightly the price of a baguette in France used to be limited, and maybe the price of an espresso in Italy.
However fixing prices comes with a bunch of problems. Some examples:
* the price might be less than the cost of producing something, in which case companies are likely to stop providing it. So you end up with a shortage of supply. Or quality might be cut to reduce costs. (Or you end up trying to control the price of everything in your economy, including labour.) If the UK fixed a price for oil, why would international oil companies sell here when they can sell somewhere else at a higher price? (The government would have to *subsidise* oil – putting tax money towards paying for it, which is another kettle of fish.)
* where there are lots of sellers it’s hard to enforce price controls. (If combined with shortages of supply this is likely to lead to a black market.) There’s likely to be a lot of bureaucracy – eg. dividing products into categories each with their own price, then monitoring these prices in the market – and lots of opportunities to exploit this bureaucracy.
* increased prices should work as a signal for more producers to enter the market and for more investment, increasing supply and potentially lowering prices again.
* fixing prices of certain goods will put people off switching to alternatives – for example, holding down the price of domestic fuel makes improving energy efficiency less attractive.
And that’s all for *specific* goods – for example, if controlling the price of domestic energy. Inflation is a *general* increase in prices across the economy, so a government would have to control the prices of a huge number of things, and this makes the problems massively worse. The ability for sellers to increase prices is essential for a market economy to function properly.
Trying to fix the level of prices generally is something countries with this kind of economy do only in extreme situations, like wartime (and even here they’ll generally use other measures).
The causes of inflation are many and varied, but what we’re seeing now is at least partly (though not entirely) “supply-side inflation”, meaning that it is caused by increased scarcity of goods and services that are in high demand. For instance, sunflower oil has gotten more expensive, because a lot of the world’s sunflower comes from Ukraine. With that country embroiled in a war with its aggressive invader Russia, the supply of sunflower has dropped. When supply shrinks relative to demand, prices go up.
You’re saying: why don’t we just fix this? But how would we do that? We can’t force everybody in the world to sell their sunflower oil at lower prices. And we probably shouldn’t want to either. Scarce goods getting more expensive sucks for people who need those goods, but it’s also an important mechanism to ensure that the supply of these goods doesn’t totally run out. If sunflower oil doubles in price, people will buy less of it, which means that people who really need it can still get their hands on it. Now, if the governments of the world all somehow agreed to force sunflower-producers to lower their prices, what’s going to happen is that the first people “in line” to buy from these producers can snatch up all the sunflower at the new low prices, even if they don’t have a great need for so much oil. (Also, they would likely then sell that oil on the black market for the true market price, but in this scenario we’ll pretend that governments can prevent that.)
Of course, that doesn’t mean that free market price dynamics result in a perfectly equitable situation. If you can’t afford to pay so much for sunflower, you’ll have to go without, even if there are still bottles on the shelves in your supermarket. But letting the market determine the price at least ensures that the small supply of sunflower that is left doesn’t get distributed randomly. And, importantly, it also encourages people to be more frugal with their sunflower oil, using it only when really necessary. E.g. food manufacturers might choose to replace it with a different oil, thus leaving more sunflower oil for those who cannot use a replacement.
The same goes for gasoline and natural gas right now. The supply is simply lower, and no government (except maybe Russia) can fix that. Governments are taking steps to ease the effect of these prices by lowering taxes, but that’s basically all they can do. And again, if you artificially lowered prices below their market price, the result would basically be that a bunch of people rush to the gas station to fill up their tanks, and then the people at the back of the line have to go without gas entirely. That’s not what you want. Given that we are in this predicament, where gasoline is in short supply, you do want prices to reflect that fact, so that people have the ability to weigh their needs against those prices (and e.g. reduce their car use). Again, it’s not perfect, because poor people especially are hit by this, but unless you can increase supply, it’s the least-worst scenario.
Housing prices would be even harder to control. Imagine you paid $400,000 for your house and now the government forces you to sell at $300,000. How is that fair? Sure, if you move and buy a new house, that new house might be cheaper too, so it might all work out okay for you. But not everybody who sells a house also buys a new one, and there’s no guarantee that all houses will go down in value proportionally. So, bottom line, you’d force a lot of home-owners to make a big loss. Not to mention the trouble this would cause with mortgages.
Deflation means there’s less money circulating. While lots of people don’t like inflation for many reasons, they hate deflation even more. Who’s money are we going to take out of circulation? Yours?
How can you control prices? Why should a homeowner be forced to make less on their home than the market suggests they could? What about a business like car dealerships that lacks inventory, so have to cover their fixed costs (rent, utilities, salaries, health insurance, etc) spread among fewer sales? What about the clothing store that has to pay an international shipping company 5x what they paid last year to get a shipping container of merchandise from China?
Even some of these companies reporting “record earnings” is somewhat artificial… they’re selling older inventory bought at lower prices, but have raised prices to account for the higher cost of new inventory. Say a store has half inventory on shelves bought last year, and half bought this year. They raised their prices 10% when suppliers raised their prices 10%, but the cost of that older inventory sold was based on the old price. But that won’t be the case next quarter, next year.
> Why can’t we just lower housing prices by law?
**Okay, so let’s think this out, and remember, this is ELI5**
I’m going to pass a law that says, *”The price of a gallon of juice is too high. Nobody can sell it for more than $4 anymore. It’s a law!”*
Great! The law has now fixed the price of juice.
But the farmer spends money on fertilizer. He spends money on people to trim the orange grove. He has a whole orange grove and he pays property tax on that. He has to buy the plastic juice jugs. He has to buy bottling equipment.
What if it COSTS the farmer more than $4 per gallon just to MAKE the juice?
What would you do in that case?
Would you say “The price should stay at $4 a gallon, so the farmer will have to figure it out for himself”?
Well, that farmer is soon going to go broke, and close the farm. And the orange trees will die off. And then nobody gets juice. No juice for you!
**Bottom line:**
You really can’t futz with the prices of things artificially too much. At least not in a capitalist system. You can’t make people buy more or less of something, and you (generally) can’t make people charge more or less for a product.
If people don’t buy your juice at $6, you better lower it, if you want to sell any. And if that doesn’t cover your costs, you can’t continue to sell juice, can you?
If people are willing to buy your juice at $7, then maybe you can try for $8 and see if they’ll pay that too.
That’s capitalism. And that’s just how it works. You can’t really tweak it much without some other negative effects elsewhere.
Latest Answers