 All right, in this presentation, we'll continue making this point about the importance of market prices. One of the fundamental reasons why free markets are so important for humanity is that free markets generate market prices, and market prices are essential to keep us well coordinated. All right? Now in this presentation, let's think about the consequences of price controls that is not allowing prices to go to their market level, but by some sort of legislation preventing them from going to the market level. And the ostensible purpose of such price controls often is to protect people from bad things. For example, rent controls, which limit the legal amount a landlord can charge and the tenant may pay in the rent control areas, they're meant to protect the tenants from charging what people consider unfair rents or rents that are too high for them to afford. So it's got a kindly origin perhaps in many cases, but bad unintended consequences can result from that. We'll talk about price gouging after a natural disaster, when it's hard to get goods into an area, typically the market prices for the short term market prices rise very high. And that's a hardship for people who have a hard time paying them. So there are laws against price gouging, which hold prices down below the market level after a hurricane or an earthquake or something. We'll consider the consequences of those, the benefits and some harms from those. And very much in the news these days is the minimum wage laws, which are a minimum, so that's a price floor, or sorry, minimum is a floor. So the people are not allowed to pay low skilled workers below a certain level. And the goal in the hearts and minds of many who support minimum wages is to have people without the advantages they do make more money. So the goals can be good, but the consequences are often negative. And we'll pay attention to those, and then we'll ask whether price controls are ever justified. Let's consider rent controls to begin with. And take a look, please, at the graph that you see. The difficulty with a rent control that doesn't allow prices to come up to the market level, which is $500 in our example, is that at the legal rent level of $400 per month, the quantity of apartments demanded is greater than the quantity supplied. The difference is going to be a shortage. There won't be enough apartments for people. Now it's good for those who already have the apartments that they're paying less than they otherwise would. Maybe some people don't get put out on the street when their lease expires and if they can't pay higher rents in a time of rising rents. So people who are in the apartments are protected. But what about those who are looking for an apartment in the city? They may simply not be able to find the apartment that they want because landlords don't have the incentive to offer all the apartments people need because the price isn't allowed to rise to the market clearing level. So the insight from this, and this is standard economics, is that price ceilings like a rent control virtually always cause shortages. There's simply not enough to satisfy the desires of all those who are willing and eager to pay that price. Let's think about the incentives there. In a situation with a rent control, such as is pictured there, what's the incentive problematic incentive for people who are in the apartments? What I have in mind here is that if you're in a bigger apartment that you need than you need, but you don't have to pay the market rate for it. You're getting a controlled agreeable low rate for it. You have a much weaker incentive to move out and allow that space to be taken up by someone else. How about the incentives on the supply side? When rents are controlled, what can you tell me about the incentive of people who might supply new apartments? They won't build them and they won't maintain the ones that are built at a decent level. Sure. Well, there are two things there. Less incentive to build new apartments if they can't charge high rents for them. In many cases around the world where there have been rent controls, there have been these terrible long-lasting shortages. Even where governments have had crash programs to build new apartments, there's still too few as long as the rents are below that market clearing level. Thomas Sowell has a wonderful description of this in his great book, Basic Economics. Then there's also that point about not maintaining them. Why would the landlord not maintain the apartments? If you can, in a lot of cases, the rent controls only apply to the people who are already there. If you can get them to leave, it's even better because you can convert it to condominiums or something. Yeah, that's right. If the apartment gets grungy enough, the people leave, and once they leave, then you can raise the rents or convert them to condominiums. But also, does a landlord need to keep the apartment in tip-top shape in order to rent it? No. No. People are desperate for apartments, so they'll come in even to the grungy areas. And also, in many times, there have been the problem that as costs of paint and plumbing and electrical work rise, but the rents don't rise. The landlords don't take in enough income to pay for the improvements in the apartments. So there was a wonderful quip by someone to the effect that rent control, for reducing the value of real estate, rent controls are second only to aerial bombardment. For reasons we've talked about. All right, let's go then on to minimum wages. With the minimum wage, which is a species of price floor that does not allow the price to come down to the market clearing wage, in the picture, the market clearing wage would be $7 an hour, but we imagine a minimum wage loss saying the price may not go down below $8 and $8.25 an hour, then we have the problem that the quantity of labor services supplied by the low-skilled workers is greater than the quantity demanded by the firms, the Wendy's, the Safeways, the McDonald's, the grocery stores that might hire them. And that leaves us with a surplus. And what do we call the surplus of labor services? Unemployment. Unemployment. And there's very little question that higher minimum wages, minimum wages above the market clearing level, are a main cause of unemployment. Not for people with our kind of education, but for people with very poor education who don't have the skills to produce for their employers goods and services value worth more than the minimum wage. What are some of the incentives for employers who are faced with higher minimum wages? If they have to pay their workers more, what might they do instead? Well, they'll either turn to automation, or if they're just talking about human labor, they're going to pick more generally reliable employees, but that will often cut out folks who can't have a car and have reliable transport to work, who are young in favor of older workers. So you'll cut the bottom rungs off the ladder, as it were. It generally tends to affect the worse off of these minimum wage workers. That's exactly right. And I like that image of cutting off the bottom rungs of the job ladder. Most people need to get a job to learn about being responsible, learn work skills, and if they can't get on to the job ladder, it's hard to climb it. And we see today that issue you mentioned about automation, if it's very expensive for the operator of a Starbucks or a McDonald's to hire new workers, they have an incentive to look for machines like kiosks where people can order or using your cell phone to put in an order rather than giving it to a human being. And so that all those problems are unintended bad effects of price controls. Now we could say more about that, but I'd like to go on to the question now of whether or not price controls are ever justified. I don't believe they are ever justified, because the argument for the coordinating effect of market prices is so strong. But it's worth considering what seems to me the strongest case for price controls. That is price controls after a natural disaster, because there people through no fault of their own are in a situation of hardship and it just doesn't seem right somehow for them to have to pay outrageous prices for the goods and services they need. Let's take a particular case, which I know about from my colleague Russ Sobel, and I'll have a story that he tells that I'll read at the end of this little discussion, about the consequences of price controls after Hurricane Hugo that hit Charleston, South Carolina many years ago. It was a category five hurricane, I think, with a huge storm surge. Charleston is low lying. And so the storm surge pushed the seawater up into the freshwater system and into the sewer water system. And so seawater and sewer water and freshwater all were being mixed around and people couldn't trust the water in their pipes. At the same time lots of trees came down and so people were without electricity. In that circumstance, what would happen to the price of bottled water in the stores? Increase supply. It increased dramatically from, say, a dollar a gallon to ten dollars a gallon. What happened to the prices of hand-pull, electric gasoline-powered generators? Also skyrocketed, because people wanted those for generators. And apparently the prices of the generators went up from what say $750 to $10,000 for a generator. The price of bottled water went up, just temporarily went up from, say, a dollar a gallon to ten dollars a gallon. In those situations, are price controls justified? Now in order to answer that question we need to think about the consequences of those price controls. What I want to do now is contrast the who would get the water and who would get the generators in the two alternatives. When water is at the market price of ten dollars a gallon, who would get the water? Another question I want you to consider is what story is that price telling? It's useful to think about prices as having a story to tell. When they go to the market level, let's start with water. When prices go to the market level of ten dollars a gallon, what story are they telling and who's going to get the water? Then we'll turn it around and I didn't finish the story for you. People did not like this price gouging and very quickly somehow the city council of Charleston passed an emergency statute saying that until further notice no one is allowed to charge higher prices after the storm than they were charging before the storm. So there was a hard rent control in the city limits of Charleston, capping prices at what they were before the storm. So those generators still had to be sold at $750. The water had to be sold at $1 a gallon. Now take a moment please and think who would get the water at $10 a gallon and what would the price that price of $10 a gallon be saying? First of all at $10 a gallon who would get the water? First of all how do you suppose my students answer this, my micro students answer this? What's the first thing that they say? If the price goes up to $10 a gallon for gallons of water who's going to get it? The wealthy. The wealthy that's what they say right away. Plausible and probably true to some extent but let's think about it a little bit more. Who would get the water at $10 a gallon? The people who have a really exceptional use for it. People who are willing to pay $10 a gallon for it who have an exceptional use for it. Hold that thought for a second to contrast it with the other way around. At the controlled price of $1 a gallon who's going to get the water? The fastest runner. The fastest runner. The people who get there first because they'll strip the shelves. And so those perhaps from the harder hit areas who get to the stores later how much water will there be for them? None. There won't be any. The shelves will be stripped. Let's think about water on the supply side. If prices go up to $10 a gallon after the storm what would you expect to happen as a consequence tomorrow and the next day? Expect you know Joe Smith to go and buy a whole bunch of gallons of water, drive into the city and sell them to people at a big markup. That's exactly right. You might expect people who hear about this, $10 a gallon for water, you might expect college students such as yourselves to say look let's rent a U-Haul truck, we'll go over to the local Walmart and fill it up with all the water we can, we'll drive to Charleston and we'll make some money. And water flows into Charleston because what is that $10 per gallon price saying so to speak? We really need it. We really need it. Fresh water is urgently needed in Charleston. Bring water to Charleston. What does the $1 per gallon price say to the rest of the world? Business as usual, everything's the way it has been. No exceptional circumstances. So both on the supply side and the demand side that $10 price is very useful. It gives those who get to the store first an incentive to leave more for others who can't get there until later and it gives an incentive for more to be brought to Charleston. Okay, let's go to the generators. At a price of $10,000 for what was a $750 generator, who's going to get the generators? Again, what do my introductory students say? The wealthy. The wealthy people, they're going to be the ones who get them. But let's think about it a little further. Who do you suppose actually, I can't say it that way, will get to who actually got the generators because the price control was in effect. But if the price control were not in effect and the generators went way up to thousands of dollars, who would get the generators and who would benefit from them? Take a moment and think. It must likely be business. Hold on, take a moment. Who would be willing to buy a generator at that? Who would buy the generators? Who would get them and who would benefit? Go ahead. If I'm a mother and my daughter has diabetes and I need to keep her insulin cold, I'd probably be willing to pay that much. If I just want to watch TV, I probably won't. You might, perhaps. Yes, that's good if you have to keep the insulin cold, yeah. That's good. Who else might be willing to pay that for a generator? Well, people who operate grocery stores would probably be willing to pay. Sure. Why? Why grocery store owners? You have to keep the food colder. It all goes bad and you have to throw it out. Suppose you have $9,000 worth of frozen food in the freezers. You're going to be willing to pay, or let's do it the other way around. If you've got $15,000 worth of frozen food in the freezers, you're certainly going to be willing to pay $10,000 for the generator. When the grocery store owner does that, who benefits? Everybody. Everybody who buys that food. Also generators were needed in Charleston because with the phone lines brought down by the falling trees, people couldn't use their credit cards and they needed cash and automated teller machines need electricity. So banks might have been willing to pay a lot for a generator to keep their ATMs going. Gasoline was needed for people's vehicles and for the chainsaws needed to clear away the limbs of the trees. But to get gasoline out of the ground requires pumps, electrical pumps at the gas stations. So gas stations might have been willing to pay that. So probably the machines would not be produced by the rich just to keep their air conditioning running. It would have been purchased by businesses who had services to provide for the rest of the community. Now with the price control in effect, who do you suppose got the generators? And I have a story that I'll read you about it here in a moment. So what do you think? Who would get the generators with the price controls in effect? Well either people get there first, people have connections. That's the way it worked. And so my colleague Russ Sobel told me this story and when I was working on my book I wrote him for it. Here's the story of actual two generators in Hugo after that awful storm. My neighbor was high school best friends years ago with the now owner of a local hardware store. So his neighbor had a friend who owned a hardware store. The store had two generators. He didn't get the store opened before the price controls took effect so he was faced with them. He kept one for his family, makes sense, and sold the other at the controlled price to my neighbor like one tenth of the free market price. Now listen, my neighbor's daughter, parentheses who was my age, the girl next door cutie, was blow drying her hair on it and my dad was going over to use his electric shaver. In the meantime the gas station, the grocery store, the bank with an ATM and the Kmart were all without power. That story of the generating that precious electricity being used for a young woman to blow dryer hair and Russ' father to use his electric shaver, that's when I urge my students to remember when they think about price controls because it's a desperate, tragic example of the misallocation of resources that occurs when prices aren't allowed to tell their story and keep us coordinated and allocate resources to where they're most believed at least to be most valuable. In conclusion then on this section of the course on prices, in closing I would say market prices are precious. They have an important story to tell and they should be allowed to tell them. So the conclusion then is for no, I don't think there's ever good reason, justification for controlling prices. The function they play of communicating information, serving us knowledge surrogates and letting us know the real condition of the availability of resources and desire for it is so important that they should always be allowed to do that. So there's a very libertarian conclusion, never under any circumstances should prices be controlled by legislation.