Lesson 10:  Price Gouging and Price Control
Among the many confused and liberal statements of former President George W Bush were
two contradictory statements that he made around the time of Hurricane Katrina:
1.  He was not going to allow so-called "price gouging."
2.  He was not going to create price controls.
They are contradictory because the defining of, and subsequent prohibition of price gouging
is the same thing as price control, just as affirmative action is the same thing as a quota
system.  

There is a difference between a price and a value.  A price can be set, a value can not.  
Individual merchants initially set and control their own prices.  However in a free market,
the two opposing forces of competition and greed rapidly force prices to be adjusted until
they reflect the true value of the item or service.  The value of something is ultimately
determined by only two things: the need or desire for it (demand) and the availability of it
(supply).  

The Free Market system is simply the environment where people trade freely: setting
whatever prices we like and getting whatever profits we can.    Never in the history of the
world has there been a more efficient and more exact system for distribution of goods and
services than the Free Market.  Letting millions of people do what they want results in
millions of tiny adjustments being made in the flow of resources, all before the Secretary of
Commerce can get out of bed.  There is no computer and no committee that can duplicate
this process.  

Unfortunately, prices can also be set by government.  Government can affect prices in two
ways.  One is to affect the price of everything by printing more or less money.  This does
not affect the sensitive, free-market distribution of resources because prices stay
proportional to their value.
*  The other way is to pass a law that sets an artificial (and
therefore arbitrary) price limit.   This is price control.

Price control separates price from value.  It thereby changes the distribution of resources
from a system based on need and availability, to a system based on standing in line and
waiting your turn.  We recognize these lines in millions of waiting rooms and emergency
rooms, where Medicare and Medicaid set price control.  In cities that enforce rent control,
we see lines of homeless people huddled in the doorways of abandoned buildings.  We
remember the lines at gas stations in the 1970's, caused by President Carter's price controls.  
And we remember hearing about the bread lines in the Soviet Union, a nation where
everyone, except those with political connections, stood in line for everything.  In Cuba,
they still do.

Price control causes shortages in two, related ways.  It restrains profit seekers and
un-restrains value seekers.
1.  It removes incentive for large profits that is required to motivate a shift in resources
towards a rising need.  A classic example is Hurricane Katrina, where fear of price gouging
laws prevented profit-seekers from providing adequate supplies.  
2.  It removes a natural, regulatory effect on demand.  In a free market, when demand
exceeds supply, prices go up which causes demand to come down.  Under price control,
value seekers (or bargain hunters) will continue to consume a dwindling supply until it is all
gone.  Consumers can be greedy too.  Examples are listed above.  

Next Lesson:  Why Are Prescription Drugs So Darn Expensive?



*There is one notable exception: Inflation affects the value of loans that are made without contractual inflation
adjustments.  That causes the bank to lose wealth.  The only way for the bank to compensate is by raising
interest rates, which in turn reduces the lending supply.