Price Regulation

Price regulation refers to government interventions that set specific price limits for goods and services within a market, aiming to ensure accessibility for consumers and prevent price spikes during shortages. This regulation takes various forms, including price ceilings, which cap maximum prices, and price floors, which establish minimum prices. Historical evidence of price regulation can be traced back to ancient laws, and it remains a prominent strategy in contemporary economics, often employed to protect consumers and stabilize essential sectors like utilities and agriculture.

However, price regulation is a contentious issue; while it seeks to make necessary goods affordable, critics argue that it can distort market dynamics, leading to unintended consequences such as shortages and the emergence of black markets. The effectiveness of price controls depends on the specific economic context and the political ideology of the governing body, as well as the implementation of transparent and sustainable practices. Furthermore, the balance between regulation and market freedom is a persistent debate among economists and policymakers, highlighting the challenges in achieving both accessibility and innovation in the marketplace.

Published in: 2021

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Subject Terms

Price Regulation

Abstract

Price regulation is a form of price control by which a government body determines specific amounts for the prices of goods and services, within a concrete market. This is done with the purpose of maintaining prices accessible to consumers, discourage price rises during periods of shortage, and sometimes, to ensure revenue for some producers, as a form of subsidy. Governments have several ways to manage price regulations, such as establishing minimum or maximum prices. Price regulation is controversial.

Overview

Authorities have long enacted different forms of price regulation; there is evidence of this practice in biblical scripture and Roman law. In the field of modern economics, price regulation refers to a strategy of market control. It usually takes the form of intervention by the government in a national or local economy, placing strictures on the behavior of producers, merchants, or other market actors, by threatening them with sanctions should they fail to abide by regulations.

Among the most common instruments used to control prices are price ceilings and floors, gatekeeping, and quality standards. A price ceiling is a restriction of the maximum price of a good; likewise, a price floor defines the minimum price for a product. Agencies may also establishing or condition the whole price structure of a specific area or regulate quantity and geographic area. Government gatekeepers may manage competition in a market sector by controlling entry into the market. Certain products are considered crucial for subsistence, in particular water, power, and other utilities, but drugs and food staples may also fall under the authority of regulatory agencies, which may put restrictions on quality and/or prices to ensure producers and retailers do not price necessaries beyond the reach of lower income consumers. Further, producers of a critical good or service may be forced to satisfy all the demand they receive and not engage in rationing or speculation in times of scarcity. Other measures include allowing or disallowing price discrimination and delimiting the action sphere of a business.

All these are actions taken by governments with a public impact in mind, which may include improving productive efficiency or better technological development; encouraging investment; ensuring a sustainable economic activity and access to goods and services for all; correcting market failures; and controlling monopolies or monopolistic activity, unforeseen externalities, and lack of information among consumers. Governments may focus on one or several of these events, and make efforts to create economic policies necessary for economic growth of both public and private actors in the market. The way that governments may go about this vary, contingent upon their specific focus and political ideology; some moves may be made to encourage foreign investment or private sector growth, for instance, or to guarantee the well-being of the largest number of people in the country by ensuring that all have access to necessary goods and services.

On the other hand, critics argue that over-utilizing these regulatory instruments pre-conditions the market, therefore hindering the unimpeded economic activity that is the natural phenomena of the free market. In other words, imposing price controls limits the capacity of the private sectors to determine their proper role in the market and modifies—even warps—the natural relationship between producers, buyers, and sellers.

For instance, determining a maximum price for the market—that is, to forestall inflationary prices—interferes with the roles of producers and consumers in determining among themselves the price of a product or market exchange, because that price has already been constricted by regulators. That is, prices will not reach equilibrium, the point at which the demand and the supply intersect. Theoretically, market forces will naturally arrive at an ideal price, one at which sellers want to sell and buyers want to buy. Price regulation frequently enforces a price below the natural equilibrium, guaranteeing to consumers what the government deems is a good's "fair price."

Another criticism relates to the link between price regulation and the rise of black markets. For example, if a maximum price or price ceiling has been established for a good, and excess demand for the good results, this unbalanced economic condition may lead to a shortage of the good. Producers and sellers may develop mechanisms to ration supply, such as following criteria related to age or amount per customer. Rationing, in turn, leads to long lines and dissatisfaction in a public used to having access to larger amounts of the good. If such a good is a necessary staple, this can cause serious societal problems. Shortages lead to the creation of a black market, the illicit contraband or trade of controlled goods, to offer the public more of these scarce goods and services.

Further Insights

A maximum price—or price ceiling—is the top limit for the price of a product, as fixed by regulating authorities. Sellers may not sell over it, as this is the legal price of a product. Ceiling prices are not arbitrarily created. They are usually imposed in times of crisis, such as wars, crop losses, or natural disasters, all of which lead to scarcity or price surges. In times of scarcity, producers and other market actors often seek to enrich themselves by overpricing the goods, or hoarding them in order to worsen the scarcity or create artificial shortages. While such actions enrich a few, they also have the potential to cause damage to large numbers of people, such as when shortages involve basic food or medicines.

Price controls may also cause unintended consequences for the communities they seek to serve. During World War II, New York City experienced a sudden increase in demand for apartments, at a time in which construction materials were needed for and diverted toward the war effort. Thus, construction came to a halt and apartments, already a scarce good, became even scarcer. To forestall speculation and a spike in rental prices, the government established rent control regulations to stop landlords from imposing large rent increases and evicting tenants without the ability to meet the higher rent. Some price controls from this period disappeared after the war, but the rent limits in New York remained, and were expanded eventually to include dwellings that used to be previously exempt from price controls. Critics argue that rent controls discouraged many from maintaining their rental properties in good condition or building more, since the artificially low rental prices led them to invest in more profitable endeavors.

Another way in which government can interfere in the market is by setting minimum prices or price floors, that is, the lowest price at which a good or service can be legally sold. A minimum price is established for a wide variety of products or services. It is also often a political action, the purpose of which is to protect consumers while also seeking to provide a guarantee a revenue to merchants and producers. Minimum prices are often created for necessary agricultural staples, such as wheat, corn, or milk, and are aimed at maintaining economic stability in that sector. These also tend to include incentives to producers for maintaining low prices, such as agricultural subsidies. Another kind of minimum price is the legal minimum wage; that is, the lowest amount possible that may be paid a worker in the labor market.

Minimum prices are meant for the greater good. According to some critics, however, minimum prices may also encourage illegal activities, such as a shadow, or "under the table," labor market. Employers unwilling or unable to pay the minimum wage may hire workers under an informal arrangement in which workers accept wages below the minimum established by law, without benefits or the protection of labor laws. The shadow workforce consists of underage workers, family members or friends "pitching in," and migrant labor working in the country without proper authorization. Because such arrangements violate the law, workers do not have the benefit of contracts or other legal work protections and run the risk of being asked to work extraordinary hours, without sanitary facilities or shelter, under dangerous or health-compromising conditions, and without the assurance of being paid.

Some countries use a type of price ceiling known as a price cap. Price caps are usually established for utilities or public services and are meant to simulate conditions as they would be if these services were in a competitive scenario: they provide businesses with incentives to reduce costs. Regulating utilities also reduces the potential effect of information asymmetry, that is, a situation in which one party has better information than the other, in this case between regulating authorities and utility services providers. Because utilities are an important public service, the state seeks to ensure that the public is well served by the quality of service and its price.

Price caps in many places ensure that basic services, such as water, electricity, and telephone, offer prices affordable to the majority. Meanwhile, governments use complex regulating formulas that make it possible for the utility provider to recover from changes that affect its costs, such as inflation, taxes, and disruptions caused by natural disasters, which would normally lead them to increase prices.

The regulation of price caps has other advantages: It provides incentives to improve efficiency and provides more pricing flexibility than regular price ceilings do. It also serves to protect consumers and among competing providers, limiting potential price increases. In short, price caps are meant to provide incentives similar to those in a free market. The forces of competition force operators to improve their quality and production. Moreover, the formulas used for price caps allows an evolution of prices through time.

Price regulations are used in other fields important to the common good, such as pharmaceuticals—drugs and medicine. The philosophy behind price regulations in the pharmaceutical industry is to guarantee—and improve—the health of patients and public safety in general, as well as to place a limit on public spending on drugs. The field of pharmaceuticals is characterized by frequent and strong interrelation between pharmaceutical producers, who also engage in much research aided by public funds, and governments. This relationship becomes weightier in countries where the government is either a partial or a unique provider of health services, as well as the regulator. A number of European nations, as well as Canada, have national health service systems. Mexico and many Latin American countries provide forms of socialized medicine to some sector of the public. In these cases, regulators focus on three objectives: The quality and safety of drugs; its accessibility; and price control.

In general, then, what modern price regulation seeks is: (1) that competitors in the market do not fix exorbitant prices, (2) ideally, to use an international frame of reference as benchmarking before determining if the market sector requires intervention, (3) to reduce price asymmetries, and (4) to implement a methodology that provides the utmost balance, that is, allows the inclusion of the higher number of goods, at the best quality for the price, and exert control on the prices. Maintaining an ideal balance in price controls is challenging, and skeptics warn that, though it is a noble concept to make necessary goods affordable and accessible, regulation needs to be managed transparently and fairly to ensure sustainability and to avoid stifling innovation and economic expansion. Finally, free market advocates discourage any type of price regulation at all, trusting the forces of the market to reach a price equilibrium to the satisfaction of all.

Issues

Several forms of price controls exist, including price ceilings, price caps, reference pricing, rate of return, tariffs, and reference pricing. Regulations inevitably exert an influence in the market, and affect the array of products available, their prices, and their incentives for development. The extent and mechanisms of price control differ across countries and sometimes, even across regions within countries. Countries such as Germany, for instance, allow open markets or freedom of price, solely for new and innovative drugs. In the United States, pricing is free and regulated by private industry. For instance, organized health insurance providers establish lists of preferred drugs and "customary" prices that they are willing to pay; medical providers and patients are encouraged to use these, by way of price incentives. For instance, they may be encouraged to use generic drugs because these are less expensive than their branded alternatives.

Other countries establish regulatory mechanisms to discourage pharmaceutical companies from charging exorbitant prices. Instead, prices are established by negotiation between government and drug providers. Critics argue that regulating prices may keep drugs affordable, but also reduce accessibility to the higher priced or higher quality drugs. However, numerous studies show that the savings accrued by governments in countries with socialized health services, often result in increasing the array of drugs offered, even if they limit the number of brands.

Price regulation impacts profits, and businesses must find ways of creating strategies that take into consideration the impact of regulations. These strategies generally seek to reduce or streamline controllable costs. However, there are costs that a firm cannot control. In some cases, the regulating authorities allow a firm to pass on to consumers some of higher costs. This has often been the case with electric utilities. Because electricity generators often have little influence over the price of fuel, and electric power is a necessary service, regulators have often allowed the power industry to pass some—or all—of the cost on to the public.

Before setting price caps or other forms of price regulations, authorities often take several steps; one of the most important of these is the price review. The price review is a process that uses several strategies, including benchmarking according to indexes such as the market price basket and an analysis of market competitiveness. It also makes allocations for inflation, uses standards for quality of service, and examines expansion targets and financial models. The result of this analysis will be a price ceiling or a price cap, with its own specific formulas and rules. A price review can be summarized in four basic steps: (1) deciding what will be regulated; (2) evaluating the existing control system or scheme; (3) Deciding the methods by which prices will be controlled, and (4) Implementing the new regulation.

In summary, there is not one fixed system or schema used to regulate prices. It depends on the government's goals and its capacity for review, control and implementation, and in the economic dynamic of the country and the sectors involved. In many instances, it is crafted through negotiation in which several actors and stakeholders participate, and the state may offer firms a series of options and trade-offs. Some of these might be that in exchange for a significant price decrease, the provider is given a subsidy or a significant tax cut. Regardless of the form of regulation, it will only be viable and successful if all participants see it as a win-win.

Terms & Concepts

Black Market: A clandestine or illegal market, also known as shadow or underground economy. Sellers and buyers in a black market are acting partially or fully outside the margins of the law.

Cost: In business and economics, cost is the monetary value of a product or service that will include a set of factors such as time, risk, effort, resources, and opportunities lost or forgone.

Equilibrium Point: An economic concept; the point at which demand and supply intersect achieving equality and perfect equilibrium.

Maximum Price or Price Ceiling: The top limit or maximum amount, usually set by law, a seller is allowed to charge for a product or a service.

Minimum Price or Price Floor: A mechanism used by government regulators to prevent a price from becoming too low.

Regulations: Statutes, rules, laws, or directives issued and established by a regulating body or authority, usually a government institution.

Bibliography

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Chan, W., & Pu-yan, N. (2016). Effects of asymmetric medical insurance subsidy on hospitals competition under non-price regulation. International Journal for Equity in Health, 15, 1–9.

Dutra, J., Menezes, F. M., & Zheng, X. (2016). Price regulation and the incentives to pursue energy efficiency by minimizing network losses. Energy Journal, 37(4), 45–61. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=asn&AN=118453017&site=ehost-live

Edwards, H. S. (2016). 4 Ways to Shoot Down Skyrocketing Drug Prices. Time, 188(16/17), 54–56. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=asn&AN=118831089&site=ehost-live

Epstein, W. N. (2017). Price transparency and incomplete contracts in health care. Emory Law Journal, 67(1), 1–58.

Erutku, C. (2017). The effects of post-Katrina gasoline price regulations: The contrast between New Brunswick and Nova Scotia. Canadian Public Policy, 43(1), 77–84. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=asn&AN=121633470&site=ehost-live

Malan, S. (2016). Price regulation and the pharmacy profession. South African Pharmaceutical Journal, 83(9), 6–7.

Ming Chen, J. (2016). Price-level regulation and its reform. Marquette Law Review, 99(4), 931–992.

Rioux, B., Galkin, P., Murphy, F., & Pierru, A. (2017). How do price caps in China's electricity sector impact the economics of coal, power and wind? Potential gains from reforms. Energy Journal, 38, 63–75. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=asn&AN=123066687&site=ehost-live

Price Regulation

On this Page

Subject Terms

Price Regulation

Abstract

Overview

Further Insights

Issues

Terms & Concepts

Bibliography

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