Price Fixing: A Flawed Approach

The wrong definition of inflation has caused a lot of harm to modern day nations as well as their economies. However, one of the biggest problems created by this misinformation is the price fixing policy. Price fixing is a flawed and failed policy which has caused taxpayers to lose billions of dollars and suffer immense turmoil as many governments all over the world repeatedly tried to implement this policy. Absolutely all implementations have been dismal failures. The reason behind this is fairly simple i.e. the policy has unsound economic fundamentals. This article makes an attempt to discuss this policy in detail:

What Is Price Fixing?

Since inflation is defined in terms of rising prices, many governments all over the world came around with an ingenious idea. The simply wanted to outlaw inflation! These governments were of the opinion that they can decide the realities of the marketplace from the parliament. Hence, let’s say if for a given year, the government fixed the price of a certain commodity at $100, it would be illegal to sell the goods at any price over $100.

Theoretically this should have ensured that the prices of the products will never rise and therefore the government can claim to have inflation under control. These policies have been widely implemented in many Communist countries. The post World War-2 Soviet Union was believed to have used this price fixing policy widely.

The Problem with Price Fixing: Free Markets:

Price fixing may in theory, solve the problem of inflation. However, in reality countries like the Soviet Union experienced runaway inflation when price fixing was being implemented. To the contrary, price fixing created disruption of the normal supply chain. It created black markets, artificial scarcity and corruption. Hence, most companies that implemented price fixing ended up with more problems than they had in the first place.

The reason behind this is fairly simple. Theoretically a person may not buy $100 rice for $102 if price controls are imposed. However, in real life a hungry person will decide to break the $100 price control law and buy the goods at whatever rates they feel are fair. Since these transactions happen in the black market, it is said that price fixing creates a lot of black markets. Also, sellers under the assumption that they may receive a higher price at a later date will try and siphon off maximum produce to the black market creating shortages in the normal market where price control laws are applicable.

Example:

The famous example given to illustrate the effect of price fixing pertains to a tank full of water. The intent is to stop the water from overflowing. The normal approach would be to switch off the tap which is supplying water to the tank. Since no more water will accumulate there will be no spilling over. This is the common sense approach and is usually used.

However, price fixing works in a different way. Price fixing does not turn off the tap. Instead under this policy you use an iron cap to cover the tank. You believe that since the cover is made up of iron, it will stop the water from flowing through.

This assumption obviously is faulty. The reason is that once the tank is full and the water still continues to flow it will cause the iron cover to burst and flow out anyway!

The Cause Has To Be Rectified:

Similarly, inflation, at its root is caused by an increase in money supply. As long as the money supply of the country keeps on increasing, price controls will not work. It will be like putting all the money in the pockets of people and then asking them not to spend it. Instead of solving the mere symptoms of inflation, a true solution can only be reached if the problem is considered from its root cause and the cause is disabled.

The marketplace is run by economic laws. Economic laws are based on the best course of action that a person can take under given circumstances. It is impossible to outlaw certain modes of behavior and make them illegal. Doing so will only lead to more government machinery for enforcing the ban and other market disruptions which will not add to the welfare of the economy in any way.

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.