What is the purpose of price setting? How does artificial lowering or raising of prices for goods\/services affect the economy?<\/p>\n\n\n\n
Sometimes the government\u2019s efforts to help businesses include raising or lowering the prices of goods. As with other government interventions, price setting throws off the balance of supply and demand and, thus, creates ill effects.<\/p>\n\n\n\n
In this article, we’ll take a look at some of the most common price setting strategies and how they affect the economy. <\/p>\n\n\n\n\n\n\n\n
When the private sector is struggling, the government may sometimes intervene by artificially raising or lowering the prices of goods and services. While this may help businesses get out of the slump, it can also destabilize the demand-supply equilibrium. Below, we’ll consider three different price-setting strategies and their effects on the economy. <\/p>\n\n\n\n
Through exports and domestic sales, there is a steady demand for agricultural goods\u2014but their prices and profits are not always as stable. During the Great Depression<\/a>, the price of farm goods plummeted, but the cost of industrial goods and farm equipment decreased only slightly. As a result, farmers couldn\u2019t make enough to buy industrial products, which shrunk the supply of farm goods, and limited supplies raised the cost of groceries. Meanwhile, many consumers had been laid off from their jobs and couldn\u2019t afford higher-priced groceries and other farm products. <\/p>\n\n\n\n Parity pricing<\/a> strategies were enacted in order to prevent this vicious cycle from repeating in the future. Parity pricing establishes a price for farm goods that is equal to the cost of the industrial goods that a farmer must buy to produce those goods. The principle behind parity pricing is that agriculture is the most basic and necessary industry in a nation, and that its prosperity benefits everyone, thus it must be protected. The fallacy behind parity pricing is that when farmers get higher prices for their goods, they\u2019ll be able to buy more industrial goods, which will support full employment.<\/strong> However, as we\u2019ll discuss next, parity pricing raises the cost of farm goods, so that the industrial workers whose jobs are supported by the farmers\u2019 supplemented income consequently face a higher cost of living. <\/p>\n\n\n\n Parity pricing is yet another example of the government artificially altering the market. This is evident in the government\u2019s various methods for raising the prices for farm goods, such as:<\/p>\n\n\n\n No matter the method, parity pricing has several ill effects. First, two of the methods listed above raise prices by reducing supply in order to increase demand\u2014the government mandates that farmers produce less, or the government pays the farmers to hold some goods off market to limit the supply that\u2019s available to sell. Although the farmer gets more money per bushel (or barrel, or whatever the measurement of a particular crop), a smaller supply of farm goods makes the nation poorer overall\u2014in other words, reducing national wealth.<\/strong> Additionally, although the parity pricing pads farmers\u2019 profits, it also limits their production and sales. This means that farmers sell fewer goods at a higher price, and their income does not increase. <\/p>\n\n\n\n Second, the parity prices that enable farmers to <\/strong>earn <\/em><\/strong>an extra dollar per bushel of wheat also mean that bread bakers have to <\/strong>pay<\/em><\/strong> an extra dollar per bushel, and the price of bread rises proportionately.<\/strong> This has different effects for two types of supermarket shoppers:<\/p>\n\n\n\n Some people argue that parity pricing helps farmers to compensate for the ways they\u2019re hurt by protective tariffs. Protective tariffs decrease imports for the farm-equipment industry in order to support American-made products\u2014but, when foreign countries export less to the U.S., they also have less money to buy American farm exports. <\/p>\n\n\n\n There are a few problems with the suggestion that parity pricing repairs the damage done by tariffs. First, while the farmer benefits from parity pricing, consumers lose twice<\/strong> because they face higher prices for goods because of tariffs as well as for groceries because of parity pricing. <\/p>\n\n\n\n Second, it\u2019s impossible to protect or subsidize every industry equally.<\/strong> If one industry is protected with a tariff, then another industry that\u2019s negatively impacted needs protection by a subsidy, which creates a ripple effect of other industries that would be positively and negatively affected. There are too many overlapping consequences to put everyone on equal footing. The only solution is to abolish both tariffs and parity pricing. <\/p>\n\n\n\n Fallacy:<\/strong> Government efforts to stabilize commodity prices protect the profits of producers, thus supporting employment and collective wealth. <\/p>\n\n\n\n Reality:<\/strong> Government efforts to stabilize commodity prices reward inefficient producers, create market instability, and reduce overall productivity and wealth. <\/p>\n\n\n\n While parity pricing applies to agriculture, the government artificially adjusts prices in other industries, as well. When the prices of goods drop, people worry that, in the time it takes supply and demand to organically adjust prices, producers will be driven out of business and employees will lose their jobs.<\/strong> These concerns lead to a call for the government to step in and stabilize commodity prices\u2014but, as with parity pricing, this effort brings unintended consequences<\/a>. <\/p>\n\n\n\n One effort to stabilize prices involves the government either buying crops off the farmers or paying them to keep some of their goods off the market, in order to raise prices by creating an artificial supply shortage. The concern behind this plan is that farmers will put their entire stock of crops on the market all at once\u2014immediately after harvest\u2014and that the surge of supply will make prices plunge and hurt farmers\u2019 profits. However, this strategy has several negative consequences, including: <\/p>\n\n\n\n Sometimes the government simply sets a higher price for goods, without restricting production. This leads to: <\/p>\n\n\n\n Both of these outcomes cause prices to eventually collapse, which creates far more instability in market prices<\/strong> (ironically out of an effort to stabilize prices) than would have resulted from relying on supply and demand. <\/p>\n\n\n\n Proponents of efforts to stabilize commodity prices believe that the speculators who buy large stocks of crops get the profits that farmers should be getting, because the speculators buy from the farmers when the prices are low, and then reap the benefits of higher prices when they resell the crops later. But in reality, the speculators act as a buffer between the farmers and the market. Since the speculators continue to sell the goods throughout the year, they provide a consistent supply to the market, which stabilizes prices for that window of time when farmers sell their goods.<\/p>\n\n\n\n Of course, prices occasionally drop as a natural result of supply and demand, and some producers are naturally driven out of business\u2014but they are the most inefficient producers in an industry. When inefficient producers shut down, it creates space for the most efficient producers to expand, and those producers are able to offer their goods at a lower price.<\/strong> As a result, consumers have access to an adequate supply of goods at a low price, which leaves them more money to spend on other things, thus supporting other industries and increasing national productivity and wealth. <\/p>\n\n\n\n Fallacy:<\/strong> Artificial price ceilings on goods help consumers by preventing the cost of living from rising. <\/p>\n\n\n\n Reality:<\/strong> Artificial price ceilings create shortages of goods, which cause the government to impose other remedies, which each create additional negative ripple effects. <\/p>\n\n\n\n The ill effects of price-fixing aren\u2019t limited to when the government artificially raises<\/em> prices, but also when it artificially lowers <\/em>prices. During wartime and other circumstances when inflation causes prices to balloon, the government attempts to help consumers by putting a ceiling on the price of goods\u2014particularly essential goods, such as food. As with other policies that involve the government\u2019s interference with the free market, the intentions may be good, but the consequences are harmful and far-reaching. <\/p>\n\n\n\n When the government keeps prices below what supply and demand would dictate, it produces several outcomes: <\/p>\n\n\n\n As a result, the government\u2019s attempt to make essential goods more universally accessible to consumers actually leads to a supply shortage. <\/strong><\/p>\n\n\n\n When this effect takes hold, the government may try to regain balance by imposing some combination of the following: <\/p>\n\n\n\n When price ceilings create chronic shortages of a commodity, consumers find substitute goods to meet their needs. As the demand grows for these substitute goods, their prices rise and their supplies drop, which can cause the government to impose price ceilings and rations, creating a ripple effect.<\/strong> This cascade of commodity shortages creates space for budding black markets, which can potentially grow to surpass the legal price-ceiling market. However, producers in the black market tend to produce less efficiently, sell poorer-quality goods, and charge more than established legal producers would under normal circumstances. <\/p>\n\n\n\nThe Consequences of Parity Pricing<\/strong><\/h4>\n\n\n\n
Parity Pricing Doesn\u2019t Compensate for Tariffs<\/strong><\/h4>\n\n\n\n
2. Commodity Price Setting<\/h3>\n\n\n\n
3. Price Ceilings <\/strong><\/h3>\n\n\n\n
Attempts to Remedy Shortages Caused by Price Ceilings<\/strong><\/h4>\n\n\n\n
3. Rent Control <\/strong><\/h3>\n\n\n\n