Price controls in groceries – it should work, but does it?

The pandemic exposed the loopholes in global food supply chains to everyone’s disbelief. For the first time, developed countries faced a challenge common in developing ones: empty shelves in grocery stores. As irregular shipping lines, disrupted ports, unavailable truckers, etc. contributed to this crisis, one might question: ‘why did the free markets not work’?

One of the rules of ECON 101 is that any demand or supply side shock shifts the equilibrium, necessitating a new price set by the market. When ignored, we are bound to have excess supply (as seen in countries where the minimum support price for some grains is well above market rates) or excess demand (when the retail price for some products is below what the market is willing to pay). Let us look at two examples where price control on goods and services started with “good intentions” but ended with “unintended consequences.”

India has a maximum retail price (MRP) for any packaged product sold over the counter, which also applies to packaged water bottles. Of course, when served in a 5-star restaurant, at an airport, or a cinema, the price for the same item would be hiked (albeit illegally) to cover the overheads. After a consumer body took this case to the supreme court, they ruled that no one could sell this above MRP. The sellers responded – in the only way they legitimately could – by refusing to stock the product.

Over time, the suppliers created a separate MRP for bottles sold exclusively in these ‘premium’ locations. Restaurants were more innovative – they would open the bottle and pour water into a glass, thus allowing them to overcome the MRP rule for “packed products.” 
Eventually, the Supreme Court ruled that restaurants provide a service, so MRP would not apply to them. How did the customers react – did they stop buying water at these locations? Of course not!

Another case of price control was a state government in India trying to limit how much Uber can charge for surge pricing. They capped it at 1.5x, hoping it would keep the rides affordable for everyone. As the demand-supply matching pattern runs on an auction model, increasing the price resulted in more supply, allowing those willing to pay the most to get off the market, which would then lower the rates progressively until it reached equilibrium. 

Unfortunately, capping the price meant the demand stayed high enough to outstrip the supply, resulting in increased waiting times. In effect, people could see an acceptable price but could not book it as no cabs were available (or they had to wait for a ridiculous amount of time). 

In addition, drivers were reluctant to accept rides when they realized that longer wait times were causing a higher cancellation rate. Ultimately, this policy hurt those who needed the ride most, as the better-off decided to use their vehicles instead. NYC tried a similar intervention with a math calculation worthy of being on the SAT, yet it failed – precisely as predicted by economists. Capping prices of other services like rental housing or GP fees in various countries has resulted in equally dismal outcomes.

‘The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.’ – Thomas Sowell.

It might be worth looking at what the government did during the pandemic to control access to food. Shutting down most of the small grocery shops, butchers, bakers, and vegetable markets meant that all supply chains only focused on replenishing two major supermarket chains. 

Not only did this concentrate the supply chain risks, it also allowed the infamous ‘duopoly’ to blossom unfettered. To ensure food stays affordable, the government warned supermarkets that they would closely watch any price movements. In return for the favour bestowed upon them by the government by letting them serve the entire market demand, supermarkets ensured that prices stayed at the pre-pandemic levels (although the regular offers vanished quickly).

However, growing pressure on prices from suppliers and overall supply chain costs meant that supermarkets had limited choices: increase the retail price, sacrifice the margins, substitute products, or avoid replenishment. Since the first option was unacceptable to the government, the second option was unacceptable to investors, and the third option was unacceptable to customers, the only possible outcome was what we all experienced – a shortage of epic proportions. It turns out that keeping food ‘affordable’ was more straightforward than ensuring it remained ‘available.’

What could we do differently next time? With cautious optimism, here are some options to consider:

• Avoid any impulse to reduce competition (small shops would have served as the natural price ceiling);
• Allow quicker import of products at an individual level (some households have already shown how consolidating purchases from Amazon AU worked for them);
• Allow farmers to sell fresh produce directly (all health and safety caveats could be displayed to let customers make an informed choice);
• Let households sell excess fruit and vegetables from their gardens (the volume of fruits rotting on pavements outside quarter-acre homes while we pay a premium at the shop is outrageous).

Param Iyer is a PhD student at the University of Auckland Business School, Department of Information Systems and Operations Management.