3. Prices and Price Controls

In a market economy, prices act as signals of scarcity. When the price of something is high, that means it's more scarce -- that is, demand for it is high relative to the supply. When the price of something is low, then it's less scarce. By observing prices, consumers and producers can choose their behavior to respond to scarcity. High prices induce producers to switch from more scarce to less scarce resources, and they induce consumers to switch from products and services that require more scarce resources to products and services that require fewer.

Throughout history, governments have attempted to influence the market with price controls, and they have met with almost universal failure. The most common form of price control is a price ceiling, a maximum price set below the market price. In response to a price ceiling, consumers increase the quantity of the good they want to consume, while producers reduce the quantity they are willing to supply. As a result, a shortage emerges. Although the price ceiling may have been intended to benefit the consumers, they will actually end up consuming less of the good in question.

Rent controls, which place a cap on prices landlords can charge for rental housing, lead to a reduction in the amount of rental housing available.

Price controls on gasoline in the 1970s resulted in long queues at the gas pumps, as consumers lined up to get their share of the reduced quantity of gasoline available.

Price ceilings also tend to breed corruption and blackmarkets, because consumers are willing to pay much more than the law allows them to pay. In the case of rent controls, potential apartment renters often pay "key fees," rental agency fees, and even outright bribes to get access to the reduced supply of housing units.

The other form of price control is a price floor, a minimum price set above the market price. In response to a price floor, producers will increase the amount they are willing to supply, while consumers will reduce the amount they are willing to buy. As a result, a surplus emerges. Often, the government is then obliged to buy up the extra. Although price floors are less common than price ceilings, they have often been used to prop up prices in agricultural markets. Another example is the minimum wage, which props up the price (wage) of labor, leading to a surplus of labor (a.k.a. unemployment or underemployment).

4. The Third-Party Buyer Effect

"No, thank you, I don't want a cocktail. Oh, they're free? Then I'll have two!" This is the third-party buyer effect. Whenever goods and services are provided at zero cost to the buyer, consumption of that thing is likely to rise dramatically unless limited in some other way. Examples:

When Canada first socialized its health care system, doctors' offices were flooded with patients seeking treatment for the most minor of illnesses (real and imagined), and doctors sent inflated bills to the government. Eventually, the government sought to limit this practice by placing ceilings on the prices doctors could charge, expecting that doctors would then start limiting the number of patients they saw. Instead, doctors avoided the price controls by decreasing the length of doctor visits and having patients visit more often (because the price controls were set on a per-visit basis).

Health insurance companies know that customers will consume large quantities of health services if the insurance company covers the full price; this is one reason why many health insurance policies require copayments and deductibles to be paid by patients.

Enrollment in colleges and universities increased rapidly after the enactment of the G.I. Bill, government-subsidized student loans, and other programs that lowered the price of education to students. (Note that the actual price of education did not fall, only the price perceived by students. The higher demand actually increased the real price of education.)