HINT: The textbook is The Economic Way of Thinking by Heyne, Boettke, and Prychitko.


In an excellent post today, Greg Mankiw writes about an unnamed competitor’s textbook:

I happened to be flipping through another introductory economics textbook. (Yes, some people have the temerity to try to compete with my favorite textbook.) I noticed an error that is, unfortunately, all too common in how introductory economics is taught. I won’t mention which book it is, because I am quite fond of the authors, and because my goal here is not to pick on one particular book but rather to draw attention to a more pervasive problem.

The issue is how one applies welfare economics to understand price controls, such as rent control and minimum-wage laws.

The sin that this book makes is to look at consumer surplus, producer surplus, and deadweight loss as if we were studying the welfare cost of a tax. The cost of a price control, the reader is taught, is the small Harberger triangle between the supply and demand curves.

This reasoning is problematic because it assumes perfect rationing. But rationing under price controls is never perfect. Under rent control, for example, apartments do not automatically go to those who value the apartments the most. The misallocation due to imperfect rationing makes the actual welfare cost of price controls much higher than the standard deadweight loss triangle.

Mankiw’s criticism is on point. But it also understates the problem. The welfare cost (efficiency loss) due to price controls includes not only the Harberger triangle, and not only the deadweight loss from misallocation among buyers that Mankiw points out. It also includes the loss from wasting time in lines.

During the 1979 shortages due to gasoline price controls, I computed that people were spending an average of about 40 cents per gallon in line. At the time, the price ceiling was about 80 cents per gallon. Economists at the Department of Energy had computed that the market-clearing price would have been about $1.00 per gallon. In other words, people were spending for gasoline, in time and money, more than they would have had their been no price controls.

Greg doesn’t mention this last factor, even though it’s potentially huge.

I looked at Greg’s textbook and it doesn’t mention this factor either, although he does a nice job of pointing out the misallocation across buyers.

But there is one textbook that has a nice diagram making my point. The authors don’t mention time per se; their term is “non-money costs.” But they show that non-money costs can combine with money costs to make the price-controlled good even more expensive than if there were no price controls. Unfortunately, in their diagram, they do assume that the goods end up in the hands of those who value them most. So it doesn’t solve the problem Greg raises. But it does show a huge cost of price controls that the unnamed textbook he criticizes does not.

That book is The Economy Way of Thinking by Heyne, Boettke, and Prychitko. In the latest edition I have (the 12th), the graph is on page 124.

UPDATE: As Alex Tabarrok points out in a comment below, his and Tyler Cowen’s text does a nice job of laying out graphically the efficiency loss from misallocation. Also Greg Mankiw points out in an e-mail, “As the commentator ‘Justin’ on your blog points out, I am bit more thorough than you give me credit for.”