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 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 fires, 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 nationalize an industry stealthily. 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?
READER COMMENTS
Thomas L Hutcheson
Feb 12 2024 at 1:14pm
Yep. Just like when the Pigou tax of an externality is too low, or zero, services of externality reduction is undersupplied.
But only economist know this.
Jon Murphy
Feb 12 2024 at 1:40pm
Only economists who do not grasp econ 101, you mean. Most Principles level textbooks cover the work of Coase and Ostrom, which show that statement isn’t theoretically correct
Pierre Lemieux
Feb 12 2024 at 2:19pm
Thomas: Thanks for your contribution. But taking the concept of externality seriously, I would add that when individuals say, read, think, or do privately something others hate, services of externality reduction are undersupplied–except under a busybody authoritarian government. Just for example, think of all the externalities that the Berlin Wall was preventing.
Jose Pablo
Feb 12 2024 at 7:47pm
undersupplied
Compare to what? If insurance prices are capped, it will be an unsupplied “real” demand, very real individuals will want to buy very real insurance and wouldn’t find it.
It is not that they will be buying less insurance than somebody thinks they “should”, they will be buying less than they “want”.
I very much think, for instance, that the market of “hands off governments that avoid the forceful collection of taxes from their citizens” is significantly undersupplied (to say the least). Since the externalities caused by taxes are well known, maybe some kind of Pigouvian taxes on overgrown governments would be required.
A Pigouvian tax on adult males with hairy legs wearing trunks, will also be very much appreciated. This “product” is, no doubt, oversupplied, very likely due to the fact that the unbearable externality caused in refined souls by this bad taste is not properly priced.
Matthias
Feb 14 2024 at 6:34am
What about Coasian bargaining?
Craig
Feb 12 2024 at 3:30pm
In South FL home insurers have now also demanded that roofs be a certain age as well. There are people replacing their roofs prematurely simply because the insurance company is requiring it and their mortgage company requires insurance.
Increasing talk in my neighborhood of simply ‘going bare’ and this isn’t ignoring the extremely obvious risk of hurricanes either. Quite the contrary, in South FL the hurricane isn’t an ‘IF’ its a ‘WHEN’
“There are other current examples. The Consumer Financial Protection Bureau is proposing to cap bank overdraft fees”
Ok….
but honestly don’t see how this flows to this –>
“The targeted large banks will likely stop offering overdraft protection (or other services) to their more risky customers”
That means they are NOT getting charged the fee though. I don’t see how preventing banks from charging fees for bounced checks is going to compel banks to stop voluntarily imposing fees for people who bounce checks?
Pierre Lemieux
Feb 12 2024 at 5:45pm
Craig: The banks have presumably chosen the least costly way to protect themselves against check-bouncing customers. Remove this and you increase their marginal cost. Increase their marginal cost and they will decrease quantity supplied (or adjust on other margins) to continue maximizing profits.
MarkW
Feb 15 2024 at 6:14am
Increasing talk in my neighborhood of simply ‘going bare’ and this isn’t ignoring the extremely obvious risk of hurricanes either. Quite the contrary, in South FL the hurricane isn’t an ‘IF’ its a ‘WHEN’
Consider that going ‘bare’ may be a sensible solution to living in an extremely hurricane prone situation. It’s the Japanese approach to home building — build cheaply and rebuilt frequently. We junk and replace pretty much everything else we own at intervals, so why not houses? That said, I think you’re exaggerating the danger. Hurricanes may be inevitable, but severe damage from them is not. I drove down the Ft Myers beach barrier island a few months after the storm. It was as big a mess as you’d imagine. But curiously, the buildings that were most affected were older wooden structures. How had they had survived so many decades up to that point? And a mile or more inland from the coast, there was not much damage at all.
I have some personal knowledge of the Florida insurance market in action, and it’s really pretty FUBAR’ed. Florida has aggressive ‘public adjusters’ who you hire after a loss to shake as much money out of the insurance company as possible. I know someone near Naples whose house had some flooding with Ian who went though this process, and the public adjuster was extremely inventive in figuring out more and more things she could claim (since the adjuster gets 10% of everything).
She also had of stories from neighbors who, working with their public adjuster and unethical roofing companies, had managed to get insurance companies to pay for entire new roofs when there was really only minor damage. So I can definitely see the logic of not wanting to insure any house that didn’t already have a fairly roof — a new roof eliminates the incentive to leverage a bit of storm damage into a ‘free’ roof replacement.
Craig
Feb 15 2024 at 10:26am
“It’s the Japanese approach to home building — build cheaply and rebuilt frequently.”
I agree, right now I’d go bare, save the premium and let it build up and if the home got destroyed I’d throw a double wide on the lot, but I can’t because ‘Dade County’, right? If you build you have to build these concrete bunkers.
“That said, I think you’re exaggerating the danger.”
Go to Tampa, you’ll see some tall trees, where I am in South FL, there’s very few tall trees. Tall compared to a person of course, but Andrew is going to happen. Most recently Dorian was that event actually and it stalled over the Bahamas and the Bahamas took that hit for South FL.
“Hurricanes may be inevitable, but severe damage from them is not.”
You can assess from the premium as compared to the cost to rebuild the probabilities and you’re right, its still a low probability event based on the premium. The premium is approximately 2-3% of the cost to build that home. TN=.003
Every 2o or 30 year there will be an ‘Andrew’ and will it focus on Homestead, the Bahamas, Port St. Lucie, that’s the peanut gallery aspect of it.
“Florida has aggressive ‘public adjusters’ who you hire after a loss to shake as much money out of the insurance company as possible.”
That goes both ways by the way.
“She also had of stories from neighbors who, working with their public adjuster and unethical roofing companies, had managed to get insurance companies to pay for entire new roofs when there was really only minor damage. ”
They will come out for a roof now. South FL (and other areas of FL), there are still shingled rooves, but they love this Spanish style terracotta roof which is pretty but relatively expensive. They’re expensive and they get sun baked, to replace a roof its 50k now and honestly what I will likely do is I’ll up the deductible to 50k.
Coming from NJ to South FL, I knew of the hurricanes of course so when I bought, mentally I wrote it off already. I don’t want to be that guy on TV, “OMG, the storm came, how could that happen, I lost everything, what am I gonna do?”
I’m going to be the guy, “I knew the big bad wolf was coming, I was ready” and unless I get a simultaneous tornado on the other side of the Apalachains in TN, I am ready.
David Seltzer
Feb 12 2024 at 6:28pm
The classic example is rent controlled apartments in NYC. Because rent controls in NYC precluded new quantity supplied, many individuals working in the city, moved to NJ or as distant as Pennsylvania. The round trip for some of them took three hours on the Northeast Regional line. An opportunity cost 0f 720 hours per annum. The unseen apartments not rented to willing tenants were potentially, finished basements with all the amenities. Why? There was a housing rule prohibiting the conversion. A landlord skirting the law could be fined or jailed. With respect Pierre, it doesn’t take an economist to understand this phenomenon as some looking for affordable housing in NYC will attest.
Jose Pablo
Feb 12 2024 at 7:59pm
President Joe Biden’s war on so-called junk fees
It is not the topic of your post, Pierre, but, what is your opinion on junk fees?
For the price signal to work properly I guess prices should be clear and known to buyers (or maybe I am just mad after some recent experiences)
They (junk fees) are popping up everywhere, like zombies in a bad movie.
Craig
Feb 13 2024 at 12:12am
The best is when you go to the car dealership and the salesman says, “Oh, you wanted a steering wheel with that? Oh, well, that’s going to be extra.”
Pierre Lemieux
Feb 13 2024 at 11:36am
Jose: Four reflections on your junk fee question. First, there is obviously a point where a “junk fee” would become fraudulent, like in Craig’s steering wheel example. Second, this line is seldom crossed on the market because consumers are not stupid and reputation has a value for suppliers. When the car buyer asks for the OTD (“out of the door”) price of the car he is thinking of buying, it includes taxes, fees, and steering wheels. Third, I am wondering if “junk fees” are not often added precisely as a way to avoid price controls. Fourth, I hear that many taxpayers find junk fees when they do their income tax returns.
Craig
Feb 13 2024 at 11:59am
Exaggerating with respect to the steering wheel of course, but even today they will never tell you their bottom line number unless you’re actually at the dealer. I’m not sure if ‘junk fee’ might even be appropriate in the context of car dealers, but there IS a game of smoke and mirrors going on. They’ll do ANYTHING not to compete on price.
Craig
Feb 13 2024 at 1:28pm
Sorry just one more minor comment here because while I absolutely 100% agree that this legislation should not be happening and if it should happen it definitely shouldn’t be happening at the federal level, one should still understand that this isn’t happening in a vacuum, it is addressing at least some perceived concern and that perceived concern I do have sympathy with. The fact many participants in the market don’t seem to be straightforward with pricing is an all too common occurrence. I experience it, many have experienced similar and that’s where this kind of legislation comes from.
Jose Pablo
Feb 13 2024 at 2:39pm
many taxpayers find junk fees when they do their income tax returns.
Many taxpayers do find junk fees when they pay for their air tickets, hotel rooms, drinks, food …
Not surprising but the government is the worst offender. In Europe it is mandatory that all displayed prices include VAT (they have to be final prices).
But when so many people (including myself) feel that they are being fooled into buying a product or service for 25-33% of what they thought they were going to end up paying, something is wrong with this way of pricing.
Maybe that happens to me because I am one of many “stupid consumers”, but if “feels” that having to be paranoic when buying anything doesn’t help with transaction costs and/or client satisfaction.
Craig
Feb 13 2024 at 2:48pm
“In Europe it is mandatory that all displayed prices include VAT (they have to be final prices).”
In the US advertising crosses state lines and even intrastate sales taxes are different, indeed there are even municipalities which differ from the county they are in, so NY state has a statewide levy, that levy can vary by county and then, on top of that, a place like White Plains can levy something over and above Westchester County. Then throw in sales tax holidays as well. I also tend to think that the European practice tends to subsume the tax in the price and people aren’t fully aware of the tax they are paying. In the US that is often the case with respect to gasoline taxes. We’re familiar that the 9/10 is a tax, but I truly doubt that most of us would know, right here, right now, without first googling it, how much the state levy is on a gallon of gas.
steve
Feb 12 2024 at 8:13pm
While I agree that price controls are bad I do think that some of the junk fees are very opaque so consumers are not aware of some of what they are paying and how much it will cost if they get hit with them.
Steve
Jon Murphy
Feb 12 2024 at 9:25pm
Except, by legislation (Consumer Financial Protection Act, the Truth in Lending Act, along with many, many others), banks have to be transparent about those fees. Whenever you go to open a bank, you get a brochure outlining all those fees. They’re posted in banks. They’re avalible on demand. ATMs will warn you.
If ignorance is at play (extremely unlikely, in this man’s opinion. When I was a banker, people had no problem telling us off about fees), it makes more sense to ask why the millions of dollars being spent on eradicating said ignorance is failing, rather than doing a reform that will only make the problem worse.
steve
Feb 12 2024 at 11:03pm
You could be correct but the ones you cite appear to apply only to loans. There are quite a few articles appearing in the last 6 months about hidden/unexpected fees so I think its at least possible there are fees where disclosure is not mandated or not well mandated like the ones at the link. Besides, I am more interested in the principle. How do markets work well when costs are hidden or at least not transparent? It’s also an issue in medicine.
Steve
steve
Feb 12 2024 at 11:04pm
Oops.
https://amberstudent.com/blog/post/top-hidden-bank-account-charges-and-how-to-avoid-them#5-inactivity-fee
J Mann
Feb 16 2024 at 10:05am
An inactivity fee makes some sense to me. As a consumer, I have had some bank accounts where I park $100 and leave it indefinitely, either because I’ve never gotten around to closing the account or because I want to use teller services occasionally at the bank while still keeping most of my money in a higher interest internet bank account.
Having thousands of stub accounts increases costs to the bank without giving them much benefit. They could avoid the problem by imposing a high account minimum or by charging a small fee to all accounts, but I’d rather have free checking for active accounts, but not for inactive ones.
That said, I avoid inactivity fees by setting bill pay to pay $0.01 to my credit card every few months, which probably costs the bank more than just leaving me alone. 😉
Jon Murphy
Feb 13 2024 at 8:47am
I am correct. I worked in this industry in the years following the Great Recession when these new regulations were being enacted.
And your link supports my point. None of those are “hidden fees.” Banks have them right up on their websites and in the literature when you sign up.
“Hidden fee” is journalistic clickbait, not a statement of fact.
Jose Pablo
Feb 13 2024 at 2:29pm
“Hidden fee” is journalistic clickbait, not a statement of fact.
“Unexpected fee”, “Not easy to anticipate fee”, “Not client friendly fee” are bad enough.
If consumers are expected to devote lots of time to understand prices, transaction costs will increase (making markets less efficient). As Thomas would say, there is a externality here worth to be addressed.
“They are not hidden” is not good enough. Clients shouldn’t need a lawyer (or a tax / commision advisor) to understand what they are going to end up paying after taxes, services fees, convenience fees, cleaning fees … “or surchages to help cover the increased cost associated with ever-growing state and local government mandates”*
* A real case in LA
Knut P. Heen
Feb 13 2024 at 11:09am
I don’t think it is ignorance. It is a form of discrimination. Price caps often come with preference for some “important” groups. Some people get as much as they want at the low price, others get nothing. For example, rent control reduces the rent for everyone who already is renting. The problem of finding an apartment to rent affect those who are looking for something to rent. A price cap on masks means cheaper masks to everyone who gets as many as they want because they have “important” jobs. The reason there is a black market for tickets (sports, music, etc.) is exactly the same. Some preferred groups get access to those tickets at a discount to the market clearing price. I am with Bruce Yandle on this one. They understand far too much economics.
Pierre Lemieux
Feb 13 2024 at 11:23am
Knut: Interesting point. Which Bruce Yandle article are you referring to?
Knut P. Heen
Feb 14 2024 at 10:55am
Baptist and bootleggers. Someone always benefits from even the dumbest regulation.
Comments are closed.