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24 Regulation 50 (2001)
The Problems of Price Controls

handle is hein.journals/rcatorbg24 and id is 52 raw text is: HEALTH AND MEDICINE History shows that these policies lead to shortages and stagnation; so why do we want to control prescription drug prices? The Problems of Price Controls By FIONA M. U NE OF THE MOST IMPORTANT issues to Americans is how to manage prescription drug prices, especially for seniors who depend on Medicare coverage. Some policy advocates are urging the federal government to con- tract directly with drug manufacturers to purchase drugs for seniors - at prices set by the government. Despite the high- minded intentions of these advocates, such price controls could be very harmful to Americans' future health. When prices are held below natural levels, resources such as talent and investor capital leave an industry to seek a better return elsewhere. This means that there will be less discovery and innovation, and fewer new drugs will become available to consumers. Often this change hap- pens over the long term - longer than the tenure of any pol- icymaker.. Thus, it is vitally important to remind policy- makers of the effects of price controls whenever they are proposed as government policy. DISRUPTING SUPPLY AND DEMAND THE DETERMINING OF MARKET PRICES THROUGH THE dynamic interaction of supply and demand is the basic building block of economics. Consumer preferences for a product determine how much of it they will buy at any given price. Consumers will purchase more of a product as its price declines, all else being equal. Firms, in turn, decide how much they are willing to supply at different prices. In general, if consumers appear willing to pay higher prices for Fiona M. Scott Morton is an associate professor of economics and strate- gy at Yale University. Her academic interests include global competitive strategy, E-commerce, and strategic management. She can be contacted by E-mail atfiona.scottmorton@yale.edu. SCOTT MORTON Yale University a product, then more manufacturers will try to produce the product, will increase their production capacity, and will conduct research to improve the product. Thus, higher expected prices lead to an increased supply of goods. This dynamic interaction produces an equilibrium market price; when buyers and sellers transact freely, the price that results causes the quantity demanded by consumers to exactly equal the supply produced by sellers. But when government adopts a price control, it defines the market price of a product and forces all, or a large per- centage, of transactions to take place at that price instead of the equilibrium price set through the interaction between supply and demand. Since supply and demand shift con- stantly in response to tastes and costs, but the government price will change only after a lengthy political process, the government price will effectively never be an equilibrium price. This means that the government price will be either too high or too low. When the price is too high, there is an excessive amount of the product for sale compared to what people want. This is the situation with many U.S. and European farm pro- grams; government, in an effort to increase farm incomes, purchases the output that consumers do not want. This, in turn, prompts farmers to raise more cows and convert more land to pasture or cropland. However, the higher prices discourage consumers from buying farm products, causing an excess of supply (e.g. a butter mountain). Gov- ernment then exacerbates this situation by continuing to purchase the excess crop at the set price. Serious problems also result when government sets prices below the equilibrium level. This causes consumers to want more of the product than producers have avail- able. When the federal government restricted gasoline price REGULATION SPRING 2001

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