How Much Should You Pay for that Chocolate Bar?

Have you heard about this economic news? Can you imagine our beloved, sweet-tooth-curing, sugary snacks becoming more expensive?

The story describes a bit of a political standoff between some of the major American food manufacturers and the United States government. Companies, such as Hershey and Kraft, want the government to increase sugar import quotas. This would allow more foreign-made sugar to be imported into the United States (it is important to note that the U.S. already imports a hefty amount of sugar from Mexico, but there is no quota, due to NAFTA). The result would be greater competition and lower prices on sugar.

More importantly, this story is a great tie-in to my earlier post, "The Economics of Price Gouging." It also relates directly to Mike's February post called, "Buy American."

In particular, the sugar quota, just like any trade quota or tariff imposed by a government, represents a PRICE FLOOR. In essence, what the government has done is created an artificial, minimum price that is above the equilibrium price of the sugar market. Now, the government didn't set a specific price, but the current quota limits the amount of sugar suppliers available to Hershey, Kraft, and the like, and keeps the price at a level greater than what the food manufacturers and confectioners would normally pay in a free market. the domestic sugar price has no chance of coming down because government has restricted competition.

Now, the argument used by food manufacturers and confectioners, is that there is a shortage of sugar, due to the quota system. This is faulty economic thinking. Sugar manufacturers were quick to point out that there is plenty of American sugar to buy. OF COURSE THERE IS! Government has created a market where prices are artificially high. The suppliers who CAN benefit from those high prices are quick to supply more sugar.

The problem is NOT a SHORTAGE of sugar. The problem IS that GOVERNMENT is keeping prices at a level that Hershey and Kraft don't want to pay.

• For what reason? To protect American sugar producers.
  
• Who pays the price? We do, with higher prices at the grocery store cash register.

ECONOMICS LESSON: The Economics of Price Gouging

Given the current economic climate in the United States, many citizens are worried about their financial well-being. When citizens are confronted with rising prices on staple products, necessary items, and generally inelastic goods, they turn to the media, government, or anyone who will listen to their complaints. We see reports in the newspaper, or on television, about "price gouging" and unsympathetic businesses hurting middle class America. But is so-called "price gouging" really a bad thing? Or, is government control of prices really doing more harm than good?

This clip by John Stossel of ABC's 20/20 was made in the wake of Hurricane Katrina. But its message and reasoning are founded in Adam Smith's view of a free market economy, and certainly apply to America's current economic situation. It offers a great introduction to the topic of price ceilings and government intervention in the economy.

So, what is a PRICE CEILING?

• A price ceiling is a legal maximum price that can be charged for a good or service.
• When a price ceiling is set below the equilibrium price, it will cause shortages.
• Price ceilings occur when government is dissatisfied with the outcomes of free markets.
  

The figure below represents an artificial rent ceiling, such as the rent control policies of New York City in the 1950s:

• When government limits the price of rental units to $400 per month, the suppliers are only willing to provide 3000 units. The market, on the other hand, is demanding 6000 units. As you can see, the Rent Ceiling, represented by the red line, has resulted in 3000-unit shortage. In addition, when 3000 units are available to rent, consumers are willing to pay $625 per month. Since the price established by government is only $400, landlords are experiencing a loss of $225 per month, per unit. That is a $675,000 loss per month by all property owners in this market.

• Some questions to think about...

1. What are some additional economic and societal effects of this situation?
2. How might third-parties be affected by this?

Points to Ponder

• Government can also set prices greater than the equilibrium price created naturally by the market. This type of price control is known as a PRICE FLOOR and results in surpluses. Suppliers are willing to supply at the artificially high price, but consumers won't buy.

• Government doesn't have to set a specific price for shortages or surpluses to occur. Interventions such as trade barriers, tariffs, and subsidies can have the same effect.