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Price ceilings and party privilege.

I. INTRODUCTION

Price ceilings in practice are often quite different from the standard textbook version. This paper analyzes price ceilings in Communist countries. They are characterized by the existence of a privileged group, namely members of the Communist Party. Price ceilings in many less developed countries are similar to those in Communist countries.

II. THE NON-DISCRIMINATORY PRICE CEILING

There are two groups of consumers, members of the Communist Party and Others. Figure 1 shows MARKET DEMAND and the demand of Party members, PARTY DEMAND. In equilibrium the price is $4 and 24 units are produced. Party members consume 9 units and Others consume 15 units.

Then the government imposes a price ceiling of $3, as shown. Because of the ceiling, only 16 units are supplied. Consumers compete for these 16 units until the cost per unit to consumers is equal to the demand price of $6. The ticket price on the item is still the official price ceiling and that is the price the suppliers receive, but demanders pay the ticket price, $3 per unit, plus the cost of the time spent waiting in line, which is equivalent to another $3 per unit.

The price ceiling is inefficient. The Dead Weight Loss is area C plus D plus E. Area C, or $21 ($3 x 7), is the Transaction Cost imposed on Party members. It is the value of the time Party members spend waiting in line. Area D, or $27 ($3 x 9), is the Transaction Cost imposed on Others. It is the value of the time Others spend waiting in line. The combined Transaction Cost is C plus D, or $48 ($3 x 16). Area E is the production cost of the ceiling. It arises from the fact that the quantity produced declines from 24 to 16. The Consumers' Surplus of Party members is area A and the Consumers' Surplus of Others is B. The Producers' Surplus is the hatched area. The price ceiling makes the consumer surpluses and the producer surplus smaller; it makes everybody worse off.

III. THE DISCRIMINATORY PRICE CEILING

Price ceilings create shortages. Because consumers are not able to buy as much as they would like at the posted price, there is need for a mechanism to control who may buy and how much each may buy. The scheme we just considered implicitly assumed that rationing was on a "First come, first serve" basis. In fact, the rationing scheme used in Communist countries (and in many Third World countries) is more complicated--and more efficient--than that. Recall that the scheme discussed above resulted in waiting lines and imposed additional buying costs of $3 per unit on all consumers.

We know from Figure 1 that 16 units are offered for sale. In Communist countries those 16 units are allocated this way: The store shelves are stocked with the 16 units and Party members are allowed into the stores first and can buy as many units as they want at the official price of $3. When the Party members are done the Others are allowed in and must compete for the units that are left.

Panel 1 of Figure 2 shows the demand curve of Party members, PARTY DEMAND. At the official price of $3, Party members choose to buy 10 units. Party members don't have to wait in lines; they incur no Transaction Cost at all. For Party members, the price is lower and the Consumers' Surplus is larger than they would be in the absence of a price ceiling. Because of their privileged status Party members benefit from the price ceiling and have an interest in maintaining it.

The Other group is not so lucky. Panel 2 shows the demand curve for Others, OTHER DEMAND. Since 16 units are supplied in total and Party members buy 10, there are only 6 units left for the others. From the point of view of the Others there is a fixed stock of 6 units, as shown. Others compete among themselves for the 6 units until the cost per unit is $7. For Others, the full price is higher and the Consumers' Surplus is smaller than they would be in the absence of a price ceiling. Others have an interest in removing the price ceiling. The price is even higher and the Consumers' Surplus is even smaller than they would be if the price ceiling was administered in a nondiscriminatory way. Others have an interest in substituting a non-discriminatory price ceiling for the one that discriminates against them.

The value of the time Others spend waiting in line is $4 per unit. Others incur a Transaction Cost of $24 ($4 x 6). Since Party members incur no Transaction Cost at all the total Transaction Cost is $24. This is less than it would be if the price ceiling was administered in a nondiscriminatory way. Discrimination reduces the Transaction Cost--but it creates a Consumption Cost.

The Consumption Cost arises from the fact that the wrong people consume some units of the goods. Ideally each unit should be consumed by that group placing the highest value on it. In the present case the last unit consumed by Party members is worth approximately $3 to them, while the last unit consumed by Others is worth approximately $7 to them. Others would be delighted to buy additional units at prices less than $7 and Party members would be delighted to sell units at prices greater than $3. Others and Party members have a common interest in trade at prices less than $7 but greater than $3. The Consumption Cost of the price ceiling is equal to the potential gains from trade between Party members and Others.

IV. THE NASCENT BLACK MARKET

The black market involving Party members as suppliers has grown enormously in recent years. Its growth reflects the re-emergence of self-interest as a motivating force in Communist countries. Once the black market develops it proves to be almost irrepressible. Certainly Party members have no interest in repressing it. Because it has the tacit approval of those in power it operates quite efficiently. In the following discussion we assume that it operates costlessly.

See Figure 2 again. Panel 1 shows the demand curve of Party members. They have already purchased 10 units. That is their fixed stock, labeled FS. The amount they want to sell at each price is their fixed stock minus the amount they demand for their own consumption. The curve labeled EXCESS SUPPLY in Panel 3 shows how many units Party members want to sell at each price.

Panel 2 shows the demand curve for Others. They have already purchased 6 units. That is their fixed stock, labeled FS. The amount they want to buy at each price is the amount they demand minus their fixed stock. The curve labeled EXCESS DEMAND in Panel 3 shows how many units Others want to buy at each price.

Panel 3 makes it very clear that Party members and Others can trade to their mutual advantage. Party members are the suppliers; Others are the demanders. They trade 3 units at the price of $6 per unit. The Others' gain from trade is area X. Party members' gain from trade is area C. The gain from trade is area C plus X. This would be the Consumption Cost of the price ceiling if trade was not possible.

The gain from trade to Party members is repeated in Panel 1 and the gain to Others is repeated in Panel 2. Look at Panel 2. Area W is the Others' gain from their initial purchase at the government store and area X is their gain from their subsequent purchase from Party members. The nascent black market makes Others better off. Others have an incentive to support the black market but they still have an incentive to oppose Party privilege and price ceiling.

Now look at Panel 1. If Party members didn't sell any units--if they consumed them all--their gain would be area A plus B. When they keep 7 units and sell 3, their gain is A plus B plus C. Their gain from trade per se is area C, which corresponds to its namesake in Panel 3. The nascent black market makes Party members better off. They view it as a beneficial adjunct to the discriminatory price ceiling.

The case we just considered eliminates the Consumption Cost of the price ceiling and therefore makes the price ceiling more efficient. It does nothing to reduce the Transaction Cost. Others still have to wait in line at the government store to buy their first 6 units.

V. THE FULLY DEVELOPED BLACK MARKET

Figure 2 shows how the black market gets started, but it does not show how the black market ends up. Initially, Party members buy 10 units with the intention of consuming them. Then they discover a better use for some of the units they have already bought. Now that the black market already exists, Party members buy much in excess of their own demand: They buy with the intention of selling. Using their Party privilege, they buy as many units as they can at the official price of $3.

Let us consider the most extreme case. Suppose Party members buy all 16 units at the official price of $3. That leaves nothing for the Others. See Panels 1 and 2 of Figure 3. They are the same as Panels 1 and 2 of Figure 2 except that the Party members' fixed stock line has moved out to 16 and the Others' fixed stock line has moved back to the price axis.

Panel 3 shows the Party members' excess supply curve and the Others' excess demand curve. (The Others' excess demand curve is their total demand curve since they don't have a fixed stock.) In this case Party members and others trade 9 units at the price of $6 per unit. The Others' gain from trade is area X. Party members' gain from trade is area C.

The Others' gain is repeated in Panel 2. Others are now indifferent between a fully developed black market and the non-discriminatory price ceiling. From the point of view of Others, either scheme is preferable to the discriminatory price ceiling with no black market or the nascent black market. It is no longer in the interest of Others to work for the removal of Party privilege, but it is still in their interest to work for the removal of the price ceiling altogether.

The Party members' gain is repeated in Panel 1. If Party members bought and consumed 10 units their gain would be area A plus B. When they buy 16 units and keep only 7, their gain is A plus B plus C. Their gain from trade is area C, which corresponds to its namesake in Panel 3. Party members, like Others, benefit when the nascent black market develops to its full potential. Party members have a stronger incentive than ever to support the ceiling, their party privilege, and the black market.

The case we just considered preserves the benefits of the nascent black market (the transmutation of the Consumption Cost into gains from trade) and it eliminates the Transaction Cost. Others don't have to wait in line for their first 6 units. Now they can buy all 9 units from Party members at the price of $6.

What used to be Transaction Cost is now a gain to society. Some is a gain to Others and some is a gain to Party members. Given that a price ceiling is going to be maintained, elimination of Party privilege and the black market would only make matters worse for all consumers.

VI. CONCLUSION

The full-fledged black market is more efficient than the nascent black market and the nascent black market is more efficient than no black market at all. The fully developed black market eliminates the price ceiling's consumption cost and transaction cost. But part of the dead weight loss still remains, namely the production cost. The fact remains that the price ceiling stifles production of the controlled good or service. Only government subsidies or direct government controls or removal of the price ceiling can eliminate that problem.

Associate Professor, Bradley University, Peoria, Illinois. I wish to thank the referee for very helpful comments on the first draft of this paper.

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Author:Felder, Joseph
Publication:Economic Inquiry
Date:Jan 1, 1993
Words:2053
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