The essential function of the price mechanism is the smooth clearance of the available supply of an economic good in a market. An economic good is a good whose supply is scarce in relation to demand ‘scarcity’ implying simply that the entire want of the society is not satisfied by the available supply.
In view of the scarcity of supply, buyers press against one another, and those who fail to offer the ruling price in the market go unsatisfied. Price thus measures the strength of excluded demand being determined by the degree of scarcity of supply relatively to the market demand. In a free price system, excess demand or excess supply tends automatically to be corrected. Excess demand is a signal for a price rise, and excess supply is a signal for a price fall. Competition among buyers and sellers brings it about that a price is settled in the market at which demand is equated to the supply. The available supply is taken off the market by those buyers who are relatively stronger and are prepared to offer the ruling price; those who cannot afford to pay the ruling price go unsatisfied. So market prices is important.
The price at which demand is equated to the supply is called by economists the normal price. In a free market, demand and supply forces can be relied on to secure the establishment of a normal price and to ensure the smooth disposal of a commodity. Each has the right to bid his own price for the commodity that he wants, and if the price offered satisfies the seller, the deal is finished without more ado. On the other hand, however intense the need that he may feel for a commodity, it remains unsatisfied unless it is backed by the power to pay a price which will satisfy the seller. The free price system is thus a delicate mechanism through which are avoided all kinds of manoeuvrings that would otherwise appear in the society as a result of the pressure of demand upon scarce supply.
Yet there is one limitation of the free price system, however satisfactory it might be in respect of the smooth delivery of goods. The system caters to the wants of stronger members of the society at the expense of its weaker members. And, since this strength is permitted to express itself in terms of the capacity to pay, the distribution of a good, as it takes place through the market mechanism, turns out to be in accordance with the relative income of buyers rather than with their relative needs. And in a society which is characterized by large inequalities of income, this certainly proves to be a serious limitation. So market prices is important.
This is the sanction for price control. If the normal price is found too high for the poorer section of the community and if it is felt that they should also be allowed to have a share of the available supply of a commodity, the State comes forward and fixes a legal maximum for the market price. A price below ‘normal’ is fixed and sellers are coerced into accepting what is deemed to be the maximum allowable, consistently with the demand coming from the relatively poor.1 A price fixed below normal does bring the controlled good within the reach of the hitherto unsatisfied buyers, although in doing so it deprives the stronger buyers of a share that would, in the absence of control, belong to them. If the control is judiciously and effectively administered, it may lead to a more desirable distribution of the available supply.
There is, however, one aspect of the matter which must not be lost sight of. The limitation of the free price system that we have mentioned arises out of large inequalities of income. It is because of this inequality that the normal price fails to satisfy the general need of the society to the extent deemed desirable. Now if this problem of inequality can be tackled directly, through taxes and subsidies, or through other measures of general income control, the case for price control surely disappears. If the income ratio between different groups in the society is brought down to the level that is considered desirable, the free price system surely comes into its own. In principle, indeed, this is a surer way of achieving the objective that we have in view. Whereas an overall income control relieves the State of the necessity of looking into individual markets, the principle of price control, since it relates to individual markets, requires a wider and a more extended supervision, its nature depending upon the character of the market and the number of commodities to be controlled. So market prices is important.
What happens if the price of a commodity is fixed by the State at a level below what it would be under the free play of the forces of demand and supply ? A state of ‘excess demand’ is created; sellers offer to sell a quantity which falls short of that which the buyers are willing to buy at the given price.
The market thus experiences ‘shortage’ a phenomenon, which is to be distinguished from ‘scarcity’ proper. For, whereas ‘scarcity’ denotes merely that some demand is excluded because the buyers cannot afford to pay the ruling price, ‘shortage’ indicates that even those buyers who are willing to pay a price acceptable to the sellers may have to go unsatisfied. Scarcity is ubiquitous in the exchange economy; the fact that a price is to be paid at all is an indication that scarcity exists. Shortage, on the other hand, is the outcome of an artificial control which puts a brake on supply but at the same time releases a demand which otherwise would remain subdued. So market prices is important.
How is this short supply distributed among the intending buyers ? Does it go to those who come first, or to those who are physically stronger and can push others out of the market? Obviously any such process would frustrate the object of price control. The technique of rationing is thus the essential corollary of a system of price control. The controlling authority undertakes to arrange a distribution of whatever supply is available at the legal price among the intending buyers according to their relative needs. This obviously means that, although people ‘at the bottom of the scale’ get a part of their demand satisfied, those at the upper end of the scale are asked to accept a ration smaller than what, with their stronger purchasing power, they could secure in a free market by bidding up prices. Here, therefore, are buyers eager to pay higher prices for an extra supply and sellers equally eager to switch on to the stronger market if only such a market can be created.
Thus the emergence of the so-called ‘black market’ is the inevitable consequence of price control and rationing. Because there are buyers prepared to buy at higher prices more than their ration coupons allow, and because there are sellers to whom the commercial code rather than the law of the land is supreme, and who are, therefore, anxious to sell their good to the highest bidder, an area tends inevitably to develop over which transactions take place at prices higher than the legal maximum its extent depending upon the degree of supervision exercised by the state towards the enforcement of law. So market prices is important.