In my last post, I introduced the idea of demand-supply curves as a useful tool for economic analysis. This time, I shall demonstrate the power of the tool to help us make sense of the world around us.
Understanding the effect of price control
Every now and then, the price of one or the other good becomes too high for the comfort of our “wise” politicos. The prompt response of those in government is to impose price controls by trying the stipulate how much producers may charge for that good. A very recent attempt at this is the ongoing effort by the state government of Tamil Nadu to prescribe the fee that schools may charge.
The toughest part of understanding price control (as it is in the case of any government intervention in the economy) is to understand the unintended effects of apparently well-intentioned actions. A sound understanding of the laws of economics enables us to do so.
Let us consider a product whose Demand-Supply curve is as given below.
Fig 1 – Demand-Supply Curve
Under equilibrium, the market throws up an equilibrium price of between 91 and 92 and the quantity exchanged is around 9 units. Along comes a politician or a government functionary who feels that a lot of people who wish to and need to consume the good are unable to do so. He comes to the conclusion that if he can force sellers to charge a lower price, many more people would be able to afford the good. So, he decides to pass an edict that no seller may sell the product at a price above 85. He is convinced that he is acting to benefit a number of people. But, is he? What actually happens?
This is best understood by super-imposing the price-ceiling of 85 on to the original demand supply curve. The result would be as below.
Fig 2 – Demand-Supply Curve with a Price Ceiling
As seen in the graphical representation above, at a price of 85, demand for the good is B (approximately 14 units) while the supply of the good is A (approximately 3 units). The result is therefore a huge mismatch between quantity demanded and quantity supplied. This situation is what we commonly call a shortage.
The good that is in short supply soon starts getting rationed. Whatever may be the method of rationing, a number of people who wish to consume the good have no way of doing so as suppliers are not willing to supply as much as they wish to consume. Thus, we see that the apparently well intentioned action of the politician results in an outcome exactly the opposite of what he hoped to achieve. The net result is that people are worse off than they were before the price ceiling was imposed.
Why will this be different in the case of education?
Frankly, it will not be. If the government tries to impose a price ceiling on education, the inevitable outcome will be that education will become unavailable to vast segments of the population that is willing to pay as per the price ceiling or even more in order to get the education. No attempt to evade this fundamental law of the market will work. In the case of education, the sufferers will be an entire generation or two of children who will be unable to get the education that is extremely critical for them to progress and prosper in their lives. What should we do as citizens? Would you be surprised if I said “Oppose this intervention tooth and nail”? What saddens me is that vast majority does not understand Economics and in fact supports this ill-thought out proposal. Talk of chopping off the very branch you are sitting on!