Market prices-IV

What does all this lead to? How are our generalizations concerning black markets affected by these considerations?   In the first place, since the black market area is dominated by stronger buyers and since, in the absence of intercommunication, sellers, strengthened by the fact of shortage, are in a position to apply discrimination to their advantage, the average of prices within the black market area (which, according to our hypothesis, exceeds the marginal demand price) tends to be higher than the normal price as it would be in a free market. The reverse may happen only if very high penalties are placed upon black market buyers. So market prices is important.

Secondly, the average price in the legal and the black markets taken together, depending, as it does, upon the level of controlled price, the level of black market prices and the area covered by illegal transactions relatively to the open market, may easily exceed the normal free market price. This tendency becomes all the more likely if control over black market dealings is slackened; for, in that case, a larger proportion of the aggregate output goes into the black market area. Thus an act of concession to black market sellers, while it may bring down black market prices as such, is altogether not certain in its effect on average price in the combined area, when account is taken of its repercussion on the volume of output available for the ‘open’ area.

Thirdly, since, if the law is to be taken at all seriously, the objective of policy must be to stop black market dealings, or, at any rate, to reduce their area to the minimum, it is a matter of indifference whether buyers or sellers or both are chosen for punishment in respect of these dealings. For it is just a question of keeping the demand curve below the supply curve in the black market region. And this of course can be done either by pushing down the demand curve through penalties on buyers or by pushing up the supply curve through penalties on sellers. Either of these operations, if carried on successfully, would serve the purpose equally well. It is for the State to decide which would be more convenient and more effective from the administrative point of view.
Lastly given the black market supply curve, the higher the penalties placed on illegal buying the lower surely is the average of prices, but the smaller also is the output sold in the black market. If, then, consumers’ surplus, is taken to be the criterion of gain to buyers to estimate which penalties, both actual and potential, as also the loss of output available, are to be taken into account it is misleading, under the pretext of price reduction, to make a scapegoat of the buyer. So market prices is important.

These considerations suggest the sort of dilemma to which a policy of price control and rationing gives rise. If control over the black market is slackened, aggregate output expands, but the legal market is left high and dry, and the scheme of rationing is endangered. On the other hand, if control over the black market is tightened, the supply in the legal market expands, but the aggregate output shrinks, and there is damage to consumer’s surplus, So market prices is important.

Note.—This is with reference to Para. 2, section III, above. On re-reading the passage I notice a certain obscurity in my formulation which needs removal.
The point made out there is that when a part of the legal market output is shared by buyers who, if it were a free market, would not have access to it, the black market demand curve takes a position above the normal demand curve. To see why it does, take a point Q on the U-curve, vertically above 7″ (Diagram III). Draw QM perpendicular to the horizontal axis (not shown in the diagram). Now QM is the price offered by stronger buyers in a free market for output OM (or RT). If, however, in view of price control, they are deprived of a part of OM, then at M where the actual amount that they buy is less than OM, their demand price is greater than QM. If Q’M (Q’M > QM) is the demand price that corresponds to this amount, then Q’ is on the black market demand curve, as it would be without risks of punishment.

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