4 Terrible Measures against High Prices
Prices continue to increase, and paying for essential goods and services is becoming more painful for the most economically disadvantaged. Governments are discussing how to revert the situation and return to normal. There are several types of measures against high prices being discussed, but in my view, most of them are terrible. Let me comment on those and tell you what I think should be done.
The problem
First of all, let’s define the problem so we can analyze our possibilities and decide what is best. High prices of something show that there is a shortage of it. Or, there is a lot of money available to buy it. Either way, there is not enough supply to meet the demand.
So if we want the price to come down and stabilize, we need to destroy the demand and encourage people to consume less. Or increase the supply, and encourage producers to produce more. So let’s take a look at what governments are doing.
4 Terrible measures against high prices
- New taxes: New taxes on the companies’ profits would cause those companies to transfer that new cost into the final product. Being the citizens, the ones that pay for those taxes. This measure results in price increment, the opposite of what we are trying to achieve.
An example: Spain readies a new tax on electric utilities’ profits – Euronews. - Give money to the citizens: Giving money to people will cause them to buy more because they have more money available. We established before, that for prices to come down, we should decrease the amount of money. Or increase the number of goods. In this case, giving people money is doing the opposite of what we should do to stabilize prices.
An example: Austria Offers 1,000 Euro Handouts to Quash Inflation Discontent – Bloomberg. - Rationing: You can distribute stamps among the citizens, and everyone will get their share of what is available. The problem with this is that it is not efficient. The resources don’t get to those that need or want them the most.
Someone that drives longer distances will need more gasoline than someone that drives shorter ones. So the person that drives longer will not get enough gas, while the other gets more than they need. This solution reduces and fixes the demand, but those that need more don’t get their needs met. So the economic output of society is smaller.
An example: Germany takes a step closer to gas rationing – BBC - Cap prices: Introducing a limit to the selling price would leave less efficient producers out of the market. Allowing only those that sell below the fixed price to sell their goods.
This inevitably leads to a shortage. Less producers are allowed to produce. Remember that the prices were initially high. So if the efficient producers could meet the market’s demand by themselves, we would not have high prices to begin with.
This is the polar opposite of increasing supply.
Imagine that you have a well of oil in your garden. You decide to rent some machinery and hire some guys to extract it. You estimate you are profitable at 100$ per barrel. If the government allows you only to sell at 80, you would be losing 20$ per barrel. In the end, you would decide not to produce because you are losing money. We have to ask ourselves what is more important, have you producing oil at 100$ or not have you producing at all.
Let’s take another example: you can produce profitably at 80$ a barrel. Just according to the government rules. But, you need new machinery, or your crew demands a higher salary if you want them to work. This will make you produce at 90$ a barrel to be profitable. Yet because you cannot sell above 80$, you will end up losing your business.
You see, in the end, capping prices results in people not producing. Just because their production cost raises and they are not allowed to reflect that increase in their selling price. Or because they are not profitable enough to sell at the price that they are obliged to.
An example: G7 agrees to explore cap on Russian oil price – Reuters
The solution: Free-market approach
Letting the price raise freely will encourage new players to produce a specific good. If the prices are very high, the profits will also be high. That would be an opportunity for less efficient producers. They now can join the market and produce in easier conditions. After a while, the production of the goods will be higher than the demand, and prices will start to come down.
Just imagine again you have a well of oil in your garden. You have never pumped oil in your life, so the chance that you are doing it efficiently and cheap is rather low.
However, if there is not enough oil in the market and the selling price is very high, it would be easier for you to take the risk and invest in the machinery you need to extract that oil. Because at high prices your possibilities of being profitable are higher.
Price controls lead to a shortage
We have seen 4 terrible measures against high prices. Only a free-market approach leads to more production solving the issue. The others lead to a shortage, are inefficient, or cause even higher prices.
During the high prices phase, people will suffer from the free-market approach. They will have difficulties accessing products. No one likes that; no one wants that. But high prices are the only way to attract new production, so the prices can come down.
The alternative to it would be to establish price controls. In circumstances where there is not enough of something, it leads to a shortage. So in the end, not only the poorer citizens would suffer, but all society in general, because the product will not be available. That is why the free market is so important.
Price has a social and economic function beyond greed and profiteering. It is a tool to communicate scarcity or availability to the market. And, channel the self-interest nature of individuals to produce what society needs at the right time.
I hope this helps you better understand some of your government’s economic measures. And, decide for yourself whether you agree or not and what party deserves your vote in the next elections. Just ask yourself this question when judging policy against high prices: Is this going to increase production, or Is it going to decrease demand? If the answer is no to both of them, most likely, they are lying to you, their policies will not bring the prices down.
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Image credited to brgfx
