Price controls and black markets

Something that Venezuelan President Hugo Chavez has never understood is the economic effects of the price controls that he imposes - or if he does understand them, he ignores them. The latest incident is reported in the Miami Herald. (Click here for article)

Price controls are implemented to prevent prices from rising to market equilibriums. At prices below equilibrium, the amount that people want to purchase exceeds the amount that firms want to sell. Normally, this would cause prices to rise inducing firms to produce more and consumers to want less until the market was in balance. When prices are held below the equilibrium price by government decree, a black market is created. A shortage of the product exists and buyers bid the price up above the equilibrium price, to the black market price, where the number of buyers is equal to the production amount that is legal.

In resource markets, the price will normally be equal to the value of the marginal product (the additional amount of output from one additional unit of input multiplied by the price of the output) Efficiency requires that resources are used in the most productive way possible.

President Chavez has subsidized the cost of urea, a chemical fertilizer, in an attempt to increase food production which is subject to price controls. In neighbouring Columbia, there are no price controls on the production of coca, the plant from which cocaine is derived. As a result, the value of the marginal product of urea is higher in the Columbian coca fields than it is in the Venezuelan corn and rice fields.

Not surprisingly, Venezuelan subsidized urea is not available to the rice and corn farmers of Venezuela, but appears to be available in sufficient quantities to satisfy the demands of Columbian coca farmers. Like it or not, Sr. Chavez, markets will prevail.