Price Fixing

On October 1, it became illegal in Maryland for manufacturers to set the minimum prices at which retailers may sell their products. Sen. Herb Kohl (D-WI) has introduced federal legislation that would do the same thing nationwide.

Legislators allege that when manufacturers prohibit their products from being sold below a certain price, they are hurting consumers. Discounters can't discount as much as they would like. Consumers have to pay more for the same products. Sen. Kohl's bill is subtly named the Pricing Consumer Protection Act.

What consumers really need is protection from politicians, not manufacturers. Contrary to popular thinking, minimum price laws can actually help consumers; conventional wisdom is not always wise.

Here's how these manufacturer price restraints work. When a manufacturer sells its goods to a retailer, part of the contract states that the retailer has to sell them to consumers at or above a given price, usually determined by a certain profit margin.

This minimum profit margin is typically on the high side. Since these price restraints are built into all sales contracts, no-frills discount retailers can't swoop in and offer a lower price. This is why some people think minimum prices are anti-competitive. They are not thinking beyond stage one.

It is worth asking: Why do some manufacturers use minimum-price requirements in the first place? After all, they help somebody else's bottom line, not their own. The answer is that they want retailers to compete with each other on non-price features — such as superior service, product demonstrations, and advertising.

Lots of goods, from high-definition televisions to cars to golf clubs, tend not to sell very well unless consumers can learn a lot about the product first. These products have high information costs. In-store displays, demonstrations, and knowledgeable sales staff are essential for getting consumers the information they need to pick exactly what they want.

Providing these services is not free for retailers. The extra profit margin built into a manufacturer-restrained price is what covers those costs. The investment pays off by increasing sales in the long run. If consumers see up close that a certain type of television is to their liking, they are more likely to buy it than if they don't get to try it out.

Up-close and personal product inspection by consumers also puts pressure on manufacturers to deliver high-quality merchandise. A well-informed customer can be very demanding. And when customers demand something, they are more likely to get it. Minimum-price agreements speed the process.

If a manufacturer couldn't require minimum-price agreements for all retailers carrying its products, then a consumer could take advantage of a free demonstration of a sound system in a specially built sound room, then buy it from a discount store that doesn't offer that kind of hands-on service. It's a classic example of what economists call a "free-rider problem."

It is also unfair competition. Without minimum price agreements, retailers who go the extra mile to inform consumers would essentially be subsidizing their competitors who don't. Why bother to inform consumers at all, then?

It is not just the economics that are unsound with the bills that Maryland has passed and Sen. Kohl has proposed. In 2007 the Supreme Court ruled that minimum-pricing agreements are legal in most cases under existing antitrust law.

The Maryland law also applies to Internet sales — even if the retailers are located out of state. In our federal system, states are only allowed to regulate entities within their borders. The bill may not survive a legal challenge.

The economy is too regulated as it is. More than 30,000 new rules came onto the books during George W. Bush's presidency, and we have been paying the economic price. Proposals to ban minimum-price agreements are just more of the same. They would keep shoppers less informed and make the marketplace less competitive. They are bad for the economy, and bad for consumers.