19 June 2017

Why Government Must Not Fix/Control Prices

Why government must not fix/control prices:

What is a free-market system? It is an economic system in which prices are decided by market forces – ie, demand and supply. In this system, a product's price is decided by the demand for that product and the supply of it. If the demand is high or/and the supply is low, then the price will be high. If the demand is low or/and the supply is high, then the price will be low.

The free-market system thus fixes the prices of all the products. It also does something else. It ensures that people get the things they want – in sufficient quantity. Example: Consider some product X which people want very much – but is not being produced in sufficient quantity. That is – its demand is high and supply is low. Then what will happen? In the free-market system, its price will be high. High price means high profits. Then other producers will start making this product to make those high profits. Then production will increase – and people will get more of this product that they want badly. Also, due to the increased supply – under the free-market system – its price will go down. Thus not only will people get more of the product that they want, but they will also get it at a lower price. So the free-market system is a double-advantage system.

So prices in a free-market system perform two functions:
1. They give information about the demand/supply for all the products.
2. They give incentives to producers to make the products that people want the most.

Now the prices of some products are very high. This means that it is difficult and expensive to make those products. Sometimes we feel the price is much higher than the difficulty and expense of making that product. If we are right, then it means the profit is very high. Then other producers must start making that product to make that high profit. And that should increase the supply – and decrease the price. If the price is still high, that means this is not happening. Which means one of two things:
a) We are wrong. Our estimate of the difficulty and expense of making that product is wrong. The product is much more difficult and expensive to make than we think. So the high price is justified.
b) Other producers are not able to make that product. That is, there is a lack of free competition and easy entry of new producers.

Some people want the government to fix the prices for expensive products. What happens when the government does this? Then the whole system described above will collapse. If the price is fixed by the government – instead of by demand and supply – then it will no longer perform its two functions. That is, it will no longer give information and incentives to producers to make that product. Then the price will be low – but the quantity produced will also be low. Then everybody who wants that product will not get it. Only some people will get it. Other people will not get it – even though they have the money to buy it. This is socialism. It is a very inefficient system. The greatest example of the socialist economic system was the Soviet Union – in which the government fixed the prices of ALL products: from grains and vegetables to shirts and trousers to televisions and refrigerators to cars and computers. The result was it finally collapsed in 1991 even though it was a superpower. It is impossible to create a more spectacular demonstration of the inefficiency of any economic system (in this case – socialism).

The solution for high prices is not the government fixing the price. High price is not the problem. It is only the symptom of the problem. The real problem is low production. And low production is due to lack of free competition and easy entry of new producers. So the real solution is to allow free competition and easy entry of new producers. Then production will increase and prices will decrease. Instead if government fixes the prices, it will be a case of the cure being worse than the disease.

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