A Strange Ignorance of the Effect of Price Caps

When a price is capped under its market equilibrium level, what happens? Few people seem to know the answer except for economists. And even some economists do as if they didn’t know, perhaps distracted by their, or their bosses’, ideology. The answer: price caps create shortages, that is, the stuff disappears from the shelves, waiting lines form, and illegal suppliers are the only recourse if you can’t wait or go without. We had many examples of this during the Covid emergency. It is easy to see all that on a simple supply-demand graph: quantity supplied decreases while quantity demanded increases. (Understanding precisely how the demand and the supply curves are built is a bit more complicated: that’s what classes in microeconomic theory are useful for.)

A current example: property-casualty insurance (“Buying Home and Auto Insurance Is Becoming Impossible,” Wall Street Journal, January 8, 2024). In half the states, property-casualty rates require government approval, at least for the non-commercial sector (information for 2011; it may be worse now). Because of higher car and house values, more frequent storms and fire risk, and increasing reinsurance rates (which government controllers don’t necessarily take into account), some property-casualty insurers have left a few states, notably California.

For the consumer, there is one thing worse than a price increase: it is to find no supplier, which is exactly what a price cap and a shortage entail. Some of the empty-handed buyers would prefer to pay more but are legally forbidden to or, what amounts to the same, their suppliers are forbidden to respond to bid-up prices.

Price caps would be a great way to stealthily nationalize an industry. Perhaps this has started for property-casualty insurance in states with “last-resort insurers,” which are government bureaus or private companies backed by state governments.

There are other current examples. The Consumer Financial Protection Bureau is proposing to cap bank overdraft fees with the virtuous goal, the Financial Times tells us, of “saving consumers billions of dollars a year and stepping up US President Joe Biden’s war on so-called junk fees ahead of the 2024 election” (“US Consumer Regulator Proposes Capping Overdraft Fees,” Financial Times, January 17, 2014; see also Nicholas Anthony, “CFRB Targets Overdraft Fees in Biden’s War on Prices,” Cato Institute Blog, January 23, 2024). The targeted large banks will likely stop offering overdraft protection (or other services) to their more risky customers, sending them to smaller and less convenient banks—less convenient as revealed by these consumers’ original choice.

Contrary to market competition, political and bureaucratic processes provide no built-in check on prices remaining higher than costs (including normal profits). As more government controls are imposed, shortages become endemic, consumers get more dissatisfied, and they cry for further controls.

On this dystopian path, nationalization under the applause of the populace would not be inconceivable. Leviathan would cap more prices and more shortages would develop. “It’s because of the supply chain.” “Is because of corporate greed.” Aren’t consumers already getting a glimpse of this future? Where is John Galt?