The Price is Right—Or Better Be!

The Price is Right—Or Better Be!

Lessons on the Folly of Political Price Regulation
February 16, 2005

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On the popular television game show “The Price Is Right,” players guess prices on  various items. The most accurate guessers win valuable prizes, and everyone—winners, losers, and the audience—has a good laugh. In reality, however, accurate prices are no laughing matter.

We assume ours is a market economy, with prices set by forces of supply and demand—yet it’s surprising how often prices reflect political rather than economic decisions. Yes, some left-leaning economists allege that private firms collude to “fix prices.” But in the true marketplace—an arena of voluntary competition and cooperation—coordinated pricing policies can actually enhance efficiency, benefiting consumers. In contrast, government price-setting policies—in industries ranging from electricity to highways to telecommunications—invariably lead to misallocation, waste, and stifling of innovation. Indeed, the pricing folly we face is regulators’ refusal to let the market “fix” prices.

There is considerably more pricing regulation than most Americans realize; policy makers should address the disconnect between existing pricing policies and real market pricing in a number of economic sectors.

Prices are important mechanisms for signaling the scarcity and productivity of both inputs and outputs of the production process. Indeed, many economists argue that the Soviet Union collapsed largely because it could never get prices right. In market economies, the right amounts of pizza, beer, and umbrellas tend to be produced because price signals impart real time, valuable information. If a locality produces too little pizza, excess demand will lift prices, making pizza production more profitable. Those profits in turn entice both existing pizza producers and new entrants seeking profits to supply more. A new price level becomes established, only to be disturbed by changing consumer incomes or tastes, or by supply-side factors such as new costs for tomatoes and cheese. The process repeats itself continuously, and does so for all marketable goods and services.

In the Soviet Union, prices set by bureaucrats were essentially phony. Pizza might have been priced according to cost, but the costs of dough, cheese, mushrooms, etc. were artificial, placed on items arbitrarily by officials. By contrast, at a humble capitalist yard sale, demand is king—prices on unsold items are reduced as the afternoon progresses. Soviet price determination was a very complex process, and once completed, bureaucrats were loath to repeat the effort. Prices remained frozen for years, despite changing consumer preferences or production costs. Goods “underpriced” relative to demand disappeared from the marketplace, while “overpriced” items sat on shelves for years. In short, Soviet prices were artificial, conveying little useful information about productivity or scarcity. This made it impossible to effectively produce the right quantities at least cost—so the system finally fell apart.

For market economies to effectively allocate goods and services, prices must also be “right.” When they are not, costly errors and inefficiencies result, as the relatively recent California energy crisis reminded us.

Despite bouts of supposed “deregulation,” there is disturbing evidence that the disconnect between actual prices in American  markets and “true” prices is far greater than generally perceived. Indeed, for some critical commodities prices are highly inaccurate—as a few examples easily illustrate.