by Zain Jaffer
One of the major issues that the 2024 US Presidential candidates have to grapple with is affordability [https://www.cbc.ca/news/world/american-voters-us-economy-1.7289112]. Many Americans struggle with food, rent, grocery, electricity, phone, and fuel bills. Some have student loans.
With inflation running high during the first years of the Biden administration, the US Federal Reserve was forced to initiate a series of interest rate hikes and bought less assets from the banks (quantitative tightening) to make borrowing debt more expensive. The government also borrowed through treasuries at higher rates, thus pulling some capital off riskier projects.
Because the higher Fed interest rates made borrowing more expensive, companies, individuals and entrepreneurs had to bear the higher cost of monthly repayments. Companies that rely on debt for operations found that a larger part of their revenues went into debt servicing. Real estate companies involved in downtown office buildings whose big projects are mostly debt financed found themselves squeezed or underwater after Work from Home (WfH), Artificial Intelligence (AI) job losses, and the like reduced the demand for office space.
As of August 2024 again there is talk of a recession. Since it is an election year, each party wants to claim it will make life more affordable. Unfortunately one of the tactics being proposed by one of these major US parties are price controls.
For those who took up Economics 101 or have even a simple understanding of economics, they know that the price is determined by supply and demand. Often there is a concept called price elasticity, where if the price changes the demand will be affected. If the demand does not change that much, it is said to be inelastic. Elasticity also applies to the supply of a good or service [https://corporatefinanceinstitute.com/resources/economics/price-elasticity/].
For example if the price of strawberries doubles, the demand will likely decrease because strawberries are an optional commodity in our grocery lists. On the other hand, if you have an infant and you need to feed them daily, you may balk and complain if the price of infant formula rises by 10%, but likely you will still buy the item because it is a necessity.
Although we will not delve deep into housing here because there are several factors that impact the current situation, the reality at the moment is that many potential buyers are hesitant to get a mortgage to buy a new house they want and elect to keep what they have because of the high mortgage rates. Sellers are also hesitant because even if they get the cash, the reason they sold is likely to move up to a bigger house, which means they also need to sign up for a higher interest rate mortgage. Thus the supply of houses is not that good at the moment. Housing affordability is one of the major issues for this coming November 2024 elections.
The problem with price controls is these often are more a publicity stunt but these do not really work. Politicians love to criticize manufacturers and retail stores for overpricing, but in reality sometimes the high prices are also caused by an imbalance in the supply to demand ratio or other factors like currency or cost of materials. One cannot simply assume manufacturers will suddenly price up an item to an exorbitant level with all things being equal, namely there is no increase in the price of the materials or manufacturing of the item/s.
The reason these do not work is that if you initiate a price control that causes the retail price to be below the cost of production of an item, the manufacturer will simply stop making it. Of course these companies are in it to make money, but they do so by providing good quality goods and services. Subverting the laws of economics with politically motivated price controls will simply backfire and give less choices to the consumers. When there are less choices and competitors in a given market, then prices will rise even more.
The right answer is to ensure there are enough manufacturers or providers so that there is no monopoly or connivance, and that there is healthy market competition. In that case pricing will be based on a market driven cost plus profit model, where customers are free to choose the items they want at the price they are willing to pay for these.