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Ch13 Surp+Short March20
ÓArmen Alchian 1999
Chapter 13
SHORTAGES, SURPLUSES AND PRICES
An investigation of "shortages" and "surpluses" will show they are results of restraints on rights to buy and sell at mutually agreeable prices. As we'll see, those restraints on price competition increase the weight of non-money forms of competition, such as social and political status, and personal characteristics. They also reduce productivity. The analysis of these effects is a good way to develop your ability to apply economic analysis. To do that, in this chapter we’ll explore the somewhat surprising meaning of “shortages” and “surpluses” that have been caused by price controls on housing, petroleum, gasoline, water and agricultural products.
Shortages and Price Ceilings;
Rent Controls, Shortages and Non-Monetary Competition
We start with an increased demand for housing space in some area. We can suppose population has increased, or some people have suddenly become wealthier. Their demand curves have shifted upward or to the right. The demand by the people who were already in the community or whose incomes had not increased are unaffected. In Figure 1, the line, labeled Da+Db, represents the community's initial demand for housing space, which here is the sum of the demands by the two groups. A and B, labeled Da and Db. The market clearing rental price is indicated by the intersection of the total demand and supply lines, and is denoted by P1. Because we are assuming the total stock of existing housing is not significantly affected by the rental price during the time covered in this analysis, the supply is indicated by a vertical straight line, labeled SS, at the existing amount of housing.
The increased demand for housing, say by the Bs, as a result of an increase in the population or wealth is represented by shifting the Bs’ demand line for housing, labeled Db', toward the right (larger amounts at any given rent). The As’ demand for housing has not increased. The new total demand, shown by line Da + Db', is larger, so it is above or to the right of the old demand curve, and therefore intersects the vertical (fixed amount) supply line at a higher price, P2.
Our first step was to relate the population or income growth to a shift in the demand. As the graph shows this implies a higher equilibrating price at which the amounts demanded equal the amount available. This equality at the same old amount supplied is achieved by the higher price which causes everyone (both As and Bs) to restrain the amount demanded at the old price. The amount they demand at the higher price is reduced.
Figure 1: Shortages by Price Controls
When demand by members of group B increases while that of group A does not, the increased total market demand implies a higher equilibrium price of housing. Housing space, indicated by the distance Xb'- Xb would be transferred to the higher valuing group B members from group A. If, however, rentals were held by law at the old level, a shortage of housing would be created. More housing would be demanded at the old, restrained, rental price -- more than exists. Allowing rents to rise avoids the shortage. Many cities have imposed rent controls, with a shortage being created immediately. (It is often proposed that the rent controls be retained until the shortage disappears. When will it disappear?)
If rents are allowed to rise in response to the increased demand for housing, the B group is able to bid space away from other present or potential occupants (those in the A group) by offering higher rents. The As end up with less housing space. Housing owners receive higher rents for the same amount of space; the space is worth more, shown by the shaded area in Figure 2. Almost everyone would blame the owners for raising rents, but in fact the Bs’ increased demands caused the higher rent. Housing owners are merely intermediaries, like auctioneers, letting the demanding tenants, the As and the Bs, compete for space. The As and Bs can be neighbors and possibly friends who complain and sympathize with each other about the higher rents, never blaming themselves for their competition for the now more highly valued space (which is what an increased demand means).
Figure 2: Wealth Transfer by Price Controls
One effect of price controls is a transfer of wealth, in the form of a greater value of housing space, from owners to existing renters. Without price controls, initial renters would pay more for the housing space (shown as the shaded area in the diagram). Subsequent renters incur costs of other forms of competition in seeking and competing for rental space.
It's almost, but not entirely, like the earlier automobile example. A difference is that the rent is paid to the housing owner, not to a former renter who "sub-leases" the apartment and moves out and relinquishes some space to the new renter. This wealth effect on tenants could be modified, of course, if everyone had to own their house (i.e., renting was not allowed.) Then the analysis would be equivalent to the automobile case. However, in the housing case, the renters are not always the owners. The owners gain by a wealth transfer in the form of higher rents, and those renters whose demands have increased gain by the right to compete for more space by offering higher rents, while the displaced renters are worse off. (However, it can be shown that the gains to the owners and to the increased demanders exceed any losses to the displaced. That is small consolation to the displaced, but it is an important reason for permitting people to compete by offering higher prices in the market.)
Shifts to Non-Price Competition
If the permissible prices are legally restrained so as not to exceed some value (less than what the new market clearing price would be), there are significant effects on behavior as people shift to other non-money forms of competition while they seek the price-controlled goods. If demanders are not allowed to offer more money than the initial rental price, a "shortage" will occur. With the new increased aggregate demand, the amount demanded at the old and restricted price exceeds the amount available. This implication is revealed in the graph by the excess of the amount demanded at the old price and the new aggregate demand over the existing supply. At the constrained price people cannot get the amount of housing space now demanded at that money price. Immediately complaints would occur about a shortage or housing crisis. Normal vacancies, which arise at market clearing rents and help people adapt and move to new locations, would disappear. Since rent is now controlled below the market clearing price, more non-money forms of competition come into effect. People would complain about "inadequate housing" and capricious, discriminatory behavior by housing owners, who now in selecting renters discriminate more by gender, marital status, age, creed, color, pet ownership, eating and drinking habits, personalities, etc. That means the full price now is more heavily loaded with non-money features. Laws passed with the intention of preventing the resulting discrimination are impossible to enforce fully. And in any event, only some stated impermissible forms of competition are affected. The fact is that “shortages” require selective allocation, and such allocation -- however conducted, whether by income, willingness to pay or color of eyes -- entails discrimination. The more pertinent issue is, "What forms of discrimination and competition for scarce resources are appropriate?"
With rent controls, people who already are renting will be able to continue to occupy the rented quarters without paying more. They cannot be induced to move to smaller quarters if rent can't be raised. Therefore, rent controls are popular with people already in a rented unit who expect not to be moving. They are able to use their prior status as a renter as an effective competitive factor against newcomers seeking space, who would offer higher rents. If new demanders are prohibited from offering higher money prices, they will seek to compete in any other permissible ways to get more space from the present occupants (so long as the worth to them of what they would get exceeds the restricted permissible money price). No frustrated demander or newcomer will idly let others get or keep something worth more than the restricted money price. Their marginal personal worth of space in excess of the permissible market price, is how much cost -- beyond payment of that money price -- they are willing to incur in other forms of competition to curry the supplier's favor and displace or reduce the space for existing occupants.
Demanders will compete in non-money offers or methods and drive up the non-money elements in the full price to the higher worth of more housing space. At the same time, the sellers will, if they are restricted from accepting more money, begin to accept more of the other forms of value or rewards offered by competing demanders. Demanders richest in good looks, color, personality, congeniality will find these features more effective in getting the suppliers favor. Gender, race, drinking and smoking habits, marital status, etc., will play a greater role. Formerly, with unrestrained money price competition, the people who are less well endowed with these other personal and cultural attributes could offset their disadvantages by offering more money. With price controls, they are not allowed to compete in that way, thereby giving non-price features greater weight. Whether that is proper cannot be decided on the basis of economic analysis. Whether or not you like that will probably depend upon your initial situation and your ability to compete in non-monetary forms. (When competitive success turns largely on beauty, grace, charm, intelligence and personality, you may do well -- but others may have great difficulties.) The point of this paragraph can be summarized: Price controls don't hold down the price, they change the form in which the price is paid.
Wealth Transfers vs. Costly Competitive Activity
The demanders now can't compete by offering more money to the suppliers. Instead they compete in other costly ways that are of less value to the suppliers. If these other methods were worth more to the suppliers, that behavior would already have been present and would have lowered the initial free-market money rent as a component of the full price. How much value does a supplier get by seeing customers compete by waiting in queues, rather than by receiving more money? The supplier would prefer to be paid with a transfer of money rather than have the demanders compete in ways that are worth less to suppliers. The demanders could, at no more cost to themselves, have provided more benefit to the seller simply by transferring money, without using up time or real resources. But the price control prohibits that. So, the demanders compete in more expensive ways, worth less to suppliers. That's a reason the increase in non-price competition caused by price controls is usually considered wasteful. But, since they compete in other ways, such as "waiting", people whose time is of lower value are "richer" in that form of payment and may be benefited by price controls. (Warning: don't jump to the conclusion that what is wasteful is necessarily "wrong" by all criteria.)
Rationing by Coupons
Some of the wastes of non-price competition under price controls can be avoided by rationing using coupons that entitle a person to buy a maximum amount of the good. But not everyone would have equal marginal worths at the amounts they were allotted by the ration coupons. The people with lower marginal worths would prefer to sell their coupons to higher-valuing people. Therefore, it has been widely proposed that ration coupons should be salable. This would benefit the person selling the coupon (who values what could be obtained with the money more than what could be had with the coupon) and would also benefit the purchaser of the coupon. Such an exchange, however, clearly reveals that the effective full price of the good is not being kept down to the official limited price. If a market develops for coupons, then the ration coupon will be worth the difference between the official price of the good and what its free-market price would be. That difference is forsaken by anyone who uses the coupon rather than selling it. Therefore, the full price for every consumer (money price plus coupon value) equals what the free-market price would be.
Changes in Supply Over Time
So far we have considered only the span of time in which the supply of housing will not have changed. If the price were controlled below the costs of maintaining the present supply and quality of houses, no increase in the amount of housing would occur despite the increased demand and higher (concealed by the controlled rent) value of housing. In fact the amount supplied would decrease in time. Typically, price controls have been placed on housing at a time when the cost of maintaining and producing housing has increased, as in times of inflation. The controlled rent is almost always less than the cost of maintaining the existing supply and quality of housing. That's not enough to make it worthwhile for the owners to replace, let alone, increase housing.
Therefore, the price controls will lead to not only an immediate "shortage", but also an eventual reduction in the stock of housing -- unless some special circumstances exist about the value of the land on which the buildings are located. (We defer an explanation of this possible exception until later chapters for an explanation of "capital value" principles which connect land values to rental values.) Ultimately, it might be the case that the quality of housing deteriorates to where it's worth only the lower rent controlled value. While that would eliminate the "shortage"(!), the outcome of deteriorated housing is the result of the price controls.