When inflation is galloping, monetary authorities can set a legal price limit for goods and services. One of the advantages of this is lower prices for consumers. Price ceilings can also stimulate demand. However, this instrument can also cause longer-term disadvantages such as a lower supply or worsening the quality of products and services. Learn more about the advantages and disadvantages in this respect by reading some experts’ opinions below.
Key Takeaways:
- The annual rate of inflation worldwide, as measured by the consumer price index (CPI), accelerated to 9.2% in March 2022, up from 7.5% in February, 6.8% in January, and 6.4 % in December 2021;
- Rapid increases in energy and food prices have raised the risk of food shortages and higher rates of inflation which are now spiking to levels not seen since the early 1980s.
- Some of the measures to limit the rise in domestic prices being considered are price control options with the aim of restricting price increases as a way to try to reduce the rate of inflation.
- Some international voices say price control should be applied only in certain specific cases.
Could you describe some of the advantages and disadvantages of setting a price ceiling as a type of price control?
“The Russian invasion of Ukraine sharply increased global commodity prices, particularly for oil and energy. This rise is expected to push up the cost of many everyday items from food to petrol and heating. The rapid growth in food prices raises the risk of food shortages, causing inflation rates to spike to levels not seen since the early 1980s. Most governments have announced measures to limit the increase in domestic prices. One of the measures considered was price control with the aim of restricting price increases as a way to try to reduce the rate of inflation. Price controls take the form of maximum prices and are used by governments as the best tool for a specific period. A maximum price means that firms are not allowed to set prices above a certain level. In general, price control is not the normal practice for all goods but it has been focused on those goods that are considered essential, e.g., oil, heating services and food. The advantage here would be for the consumer, who would enjoy lower prices for certain goods and services. Price controls aim to stop firms from profiting from market shortages and keep prices affordable for all categories of consumers. This tool is important for monopolistic markets (e.g., in the case of Albania where one firm has the monopoly over gasoline). Setting the limit on price increases can ensure prices don’t surge without causing a shortage of the goods. The disadvantage is that it will lead to lower supply. Price caps encourage companies to produce less of a product and of a lesser quality whilst making the product more attractive to consumers. Supply goes down and demand goes up, with shortages being the inevitable result. A maximum price can lead to the emergence of black markets as consumers try to overcome the shortage of goods and pay well above the market price. Price control increases government bureaucracy and interference. With price controls, there is wasteful spending on government bureaucracy. In addition, firms may complain that the government agency is not just setting prices but increasingly controlling which goods they can sell. The black market – another problem of price controls is that it is likely to cause growth in the underground economy.”
“The price ceiling introduced by the government can be justified in only two cases. Firstly, to prevent unjustified price increases by monopolies on a permanent basis. Secondly, as a temporary measure against the rapid rise in prices for essential products (e.g., basic foodstuffs, drinking water, basic medicines, fuel and other essentials) in the event of a rapid supply shortage caused by force majeure. However, price ceilings, even in the short term, always lead to a shortage of supply, or administrative restrictions on the purchase of regulated goods through the introduction of distribution lists, coupons, cards or the use of electronic means. As a result, it creates a black market with much higher prices and leads to corruption of those officials responsible for controlling, distributing and restricting procurement. Therefore, price restrictions and other administrative measures can only be used as an immediate response to emergencies, but should be replaced by economic measures as soon as possible.”
“As of today, legally restricting the price limit is vested with thegovernment (fiscal authorities) as the government can either procure food items from the producers (farmers) directly and then supply these to the targeted group of citizens who are affected by the price rise at a subsidized price. This is what we term as the Public Distribution System (PDS). If the prices are very high even when the demand is neither so high nor the supply is so low, then it becomes a bounden duty for the government to identify the hoarders of essential items, seize them, and bring them to the common pool. On the other hand, if the demand is higher and supply is less, this results in price rises and the government can bring many policy measures to ensure that the essential items are equitably distributed across the population and put a check on the wastage of essential items. When India faced food grain shortages in the past, Mr. C. Rajagopalachari, then the Chief Minister of Madras Presidency in India, restricted the number of people attending various functions where food wastage was huge. If fuel is on shortage, government can impose penalty on people using personal vehicles and thereby disincentive them to use personal vehicles andpush them to public transport. The role of monetary authorities is very much restricted as they can take reactive actions on the price rise like increasing the interest rate and thereby reducing the cash flow in the society and therebyartificially restrict the demand. The Federal Reserve Bank is invariably entrusted with the responsibility of money supply and monetary restrictions.”
See also: What are the solutions for stabilizing inflation? | Experts’ Opinions
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