Suppose, for the sake of argument, that the government passed a law that said all cars must be sold for $25,000. What would the effect be on the marketplace?
Basic economics teaches us that price floors, that is mandating a minimum price that is above the market price, will result in surpluses: goods that no one wants to buy because the price is too high. Price ceilings, or a maximum price that can be charged for a good, will result in shortages. When the maximum price for a gallon of gas is $1.00, and people are willing to pay $3.00…no gas at the station.
The above analysis assumes uniform goods and uniform quality. A gallon of gas is a gallon of gas, despite what Shell and BP would have you believe. But what happens when we inject quality into the mix?
If we mandate a price for a good, it acts as both a price ceiling and a price floor. Goods whose real price is above the target will be scarce, and goods whose real price is below the target will be in surplus. Back to the car example…if we say all cars must be sold for $25,000, there will be a heck of a lot of used Kias for sale. Those sellers are getting a price far above what the market would be willing to pay for their crappy car. However, there aren’t going to be a lot of new BMWs on the market…sellers aren’t going to be willing to give away their cars for less than they are worth.
The same analysis holds with respect to labor. If I say, for example, “All teachers make $50,000 a year” then those people whose labor is worth less than $50,000 have a strong incentive to give up that DMV job and get into teaching. Likewise, those whose labor is worth more than that will look for other work. Did I mention that almost every school system in the country has mandatory pay scales…strongly supported by teachers’ unions?
So the next time you read stories like these, consider who is doing the bitching.
The two things you need to know about economics: incentives matter, and there’s no such thing as a free lunch.