Price as a Rationer
There have been many cases throughout history in which
governments have been unwilling to let prices adjust to clear markets. Instead, they have established
either price ceilings, which are prices above which
it is illegal to buy or sell, or price floors, which
are prices below which it is illegal to buy or sell.
If a price ceiling is placed below the market-clearing
price, as Pc is in the supply and demand diagram shown below, the
market-clearing price of Pe becomes illegal.1 At the
ceiling price, buyers want to buy more than sellers will
make available. In the graph, buyers would like to buy
amount Q4 at price Pc, but sellers will sell
only Q1. Because they cannot buy as much as they
would like at the legal price, buyers will be out of
equilibrium. The normal adjustment that this disequilibrium
would set into motion in a free market, an increase in
price, is illegal; and buyers or sellers or both will be
penalized if transactions take place above Pc. Buyers
are faced with the problem that they want to buy more than
is available. This is a rationing problem.
Price ceilings are not the only sort of price controls
governments have imposed. There have also been many laws
that establish minimum prices, or price
floors. The graph below illustrates a price floor with
price Pf. At this price, buyers are in equilibrium,
but sellers are not. They would like to sell quantity
Q2, but buyers are only willing to take Q3. To
prevent the adjustment process from causing price to fall,
government may buy the surplus, as the U.S. government has
done in agriculture and in precious metals. If it does not
buy the surplus, government must penalize either buyers or
sellers or both who transact below the price floor, or else
price will fall. Because there is no one else to absorb the
surplus, sellers will.
Rationing is necessary to deal with scarcity.2
When an item is scarce, people must sacrifice something in
order to get as much of the item as they would like to have.
There are some goods that are not scarce. Air is an
example--it is free to all who want to breathe it. Ice is
not scarce in Greenland. But almost all other goods are
scarce. Price is a way to ration goods. It deprives those
who do not have enough income or desire for a product. The
function of price as a rationer is most clearly seen when
price is prohibited from acting as a rationer, so that some
other method of rationing (such as queuing
or coupon rationing) must emerge or be developed.
1This discussion of price ceilings and floors assumes that markets are competitive with many
buyers and sellers. The effects of price controls in non-competitive markets. markets that have only one or a very few buyers or
sellers, can be quite different and are discussed in readings about monopoly.
2Note that scarcity
is not the same as shortage. Scarcity exists whenever some
rationing process must be used. A shortage indicates that
price is below market-clearing price.