Prices
Prices
For the general considerations underlying the determination of individual prices, seeDemand and supplyandUtility. The first article presented below discusses problems of price setting in noncompetitive markets. See alsoMonopolyandOligopoly. For price determination in competitive markets, seeCompetition. The second article discusses the role of prices in a free market economy and government regulation of prices. For closely related elements of government regulation, seeResale priceMaintenanceandRegulation of industry. The third article discusses historical aspects of the movement of the general level of prices. For analytical treatment of general price level movement, seeInflation and deflation; for problems of measurement, seeIndex numbers.
I. Pricing PoliciesWilliam S. Vickrey
II. Price Control and RationingBen W. Lewis
III. Price HistoryEarl J. Hamilton
I PRICING POLICIES
In the strict theory of perfect competition, price policy has no role. Prices are assumed to be determined by an impersonal and automatic market mechanism that operates to adjust prices so that quantities demanded and supplied at the given price are equal. Price policy is therefore inherently associated with imperfect competition, even though in some cases the competition, though imperfect, is sufficiently active to impose very narrow constraints on the price policies that individual firms can follow without disaster.
Where only a single product is involved, with a single price, distinguishable pricing policies include marginal-cost pricing, average-cost or fullcost pricing, uniform monopoly pricing, and stayout pricing. Of these, only marginal-cost pricing corresponds to the full rigor of competition; it is usually considered to be the price that, theoretically at least, is most conducive to efficient allocation of resources. It is generally the most volatile of the pricing methods, resulting in extremely low prices at times of excess capacity, particularly in highly capital-intensive lines, and correspondingly high prices in periods of shortage. This volatility has made marginal-cost pricing quite unpopular, as compared with average-cost or full-cost pricing. Average-cost, or full-cost, pricing is, in a sense, the modern equivalent of the medieval just price, in that it gives priority to the goals of stability and equity between buyer and seller rather than to economic efficiency. Monopoly pricing, at the other extreme, represents giving full rein to the cupidity of the seller. While stay-out pricing, i.e., pricing calculated to discourage the entry of potential competitors, is in essence merely a prudential variant of monopoly pricing and thus is in theory subject to similar opprobrium, it usually involves less flagrant exploitation of purchasers and is, in practice, not often referred to by this name. Indeed, much of what is termed “full-cost pricing,” but with capital charges and rents often included in costs at fairly generous levels, is in reality a form of stay-out pricing in that the firm’s own costs are often a fairly good indicator of the costs that a potential competitor might face.
Marginal-cost pricing
Where heavy fixed costs are involved in the production of nonstorable goods and services, fluctuation of demand or supply or both gives rise to drastic fluctuations in marginal cost, and one would theoretically expect that competitive pressures or a desire to promote efficiency would produce corresponding variations in price. Actually, inertia, tradition, and administrative constraints have combined to keep such variation to a minimum. In resort areas, seasonal variation in hotel rates is common, particularly where competition is keen, but comparable variation in rates in nonresort areas is rare. Although downward deviation from a “standard” rate in slack seasons seems generally acceptable, upward variation in periods of specially heavy demand (for example, during fairs and festivals) is generally considered to be unethical and in some jurisdictions is unlawful. Nevertheless, even where the nominal rates remain the same, some variation occurs in the effective rates. Price differentials for different accommodations may not vary commensurately with their attractiveness, so that as demand increases, latecomers must pay substantially higher rates for only slightly better accommodations, or, as in the case of Pullman upper berths, must be content with inferior accommodations at a rate differential at which they would ordinarily go begging. Variation of box office prices on short notice has been inhibited by excise tax regulations, and where speculators have stepped in to adjust demand and supply, they have often been subjected to legal penalties.
Sometimes price actually varies perversely with the intensity of demand, a practice rationalized in some instances by an appeal to the notion of a discount for quantity purchases and in others by average-cost calculations involving inappropriate cost allocations. Thus commutation fares used primarily for the regular rush-hour journey to work are usually priced far below the one-way fares paid by casual riders, who are much less heavily concentrated in the rush-hour periods, and are often priced below even the special reduced excursion fares offered for nonrush-hour trips. Similar concessions are often offered for bridge tolls; in neither case can the size of the concessions be justified by savings in collection costs.
Injection of “value of service” concepts, in conjunction with nominal uniformity and historical continuity, sometimes leads to bizarre and costly rate patterns. For example, long-distance telephone rates in the United States are generally based on airline distances, requiring a costly look-up procedure to assess the charge for each call; a toll schedule based largely on direct-dialing code zones would be both more in line with costs and less expensive to apply. Again, evening rates apply according to uniform nominal local time at the point of origin. This sounds like an even-handed procedure, but it results in a Boston caller being able to call a Seattle friend at the reduced rates and reach him at a mutually convenient evening hour, whereas Seattle may not call Boston at the night rates without having to rouse the Boston party out of bed. The staggering mass and complexity of American freight rates is notorious.
Even where substantial differentiation between peak and off-peak rates occurs, as in long-distance telephone service, it usually falls far short of the degree of differentiation that would lead to efficient utilization of the facilities. Where the capacity limit is sharp, with no deterioration of quality of service short of capacity and no possibility of supply exceeding capacity in the short run, the efficiency, or marginal-cost, rule is clear: as long as capacity is not fully utilized, price should reflect only operating costs with no contribution to capacity costs; when capacity would be exceeded at this price, the price should be adjusted upward until demand is restrained to the capacity level. Under constant returns to scale, when the capacity charges thus collected just defray capacity costs, capacity is appropriate. When capacity charges determined in this way exceed capacity costs, the installation of additional capacity is indicated, while in the reverse case existing capacity is excessive.
Carried to its logical limit, such a price policy would cause sharp variations in price not only between the peak and off-peak periods of a recurring pattern, but also between one year and the next. This would be particularly true where mistakes are made in the prediction of demand, or where it is necessary or economical to add to capacity in fairly large units. In some cases the results of following such a prescription literally might appear quite inequitable. Thus when a new transit facility is developed in one sector of a city, users of other more crowded facilities in other quarters may feel sufficiently discriminated against because the users of the new facility are (for the time being at least) relatively less crowded without, in addition, their being favored with lower fares. Again, when a large new unit such as a bridge is financed by tolls, these tolls are often imposed immediately upon completion, when traffic is insufficient to cause congestion, and are removed when the cost of the unit has been amortized and when congestion is sometimes beginning to build up.
Indeed, it is often felt that variations in shortrun marginal cost are so sharp and erratic as to have no relevance for price policy. In many cases the marginal cost that would be relevant to setting prices so as to guide decisions toward efficient utilization of facilities would reflect not costs imposed on the supplier but costs imposed on fellow users. In the short run a surge of traffic on a transit line, a road, or a telephone system may have no discernible effect on the costs of the operating agency, but will have as its cost a deterioration of the quality of the services rendered through increased crowding of riders, increased delay to motorists, or increased probability that a call cannot be completed promptly because the circuits are all busy. If marginal cost is measured in these terms, the fluctuations may still be great, but they will not be quite so erratic as a strict allocation of capacity costs might indicate. Here again, an appropriate level of capacity will have been reached when the cost of additional capacity would just balance the value of the improvement of service that the added capacity would provide for the actual level of traffic. This cost, in turn, given reasonable continuity of the production function, will equal the charges assessable on a volume of traffic equal to the increment that the added capacity would make it possible to carry at the original level of service quality.
However, it is seldom possible to apply this criterion directly, since in most cases prices are not in fact made to vary as widely as even this interpretation of marginal cost would suggest. Aside from popular prejudice against extreme variations in rates as being unfair or discriminatory, a rational motivation can be attributed to regulated public utilities that would make them reluctant to curb peak use quite this strongly. A utility company is often assured of a “fair” rate of return on its investment, provided only that a case can be made that this investment is needed in providing the service, and some margin is usually allowed between the actual cost of capital to the utility and this fair rate of return. In such cases the interests of the management, both as representatives of the stockholders and in terms of their own prestige and position of control, will be to maximize the amount of investment that is justifiable. This can be done by setting rates so as to maximize the net revenue derived from off-peak service. If peak rates must then be set below cost in order not to exceed the over-all rate of return allowable, a higher peak demand will result and will justify a larger capital investment than would be justified if rates reflected relative marginal costs. One can expect, accordingly, that only rarely will rates vary as widely as costs.
Administered and reactive prices
Another differentiation among price policies is that between predetermined, or “administered,” prices and “reactive,” or market-determined, prices. Administered prices tend to be more stable and predictable, thus providing a basis for planning by both buyer and seller that may be felt to lead to more efficient results. If prices are set some time in advance, potential buyers have an opportunity to make plans on the basis of a known price, and at the same time may be protected from certain types of losses that might occur if they made commitments without being assured of the prices that would prevail when they came to carry them out. On the other hand, setting prices in advance may lead to premature commitment by parties who are thus protected against the effects of future developments, and may inhibit taking advantage of opportunities that develop unexpectedly.
In principle, a distinction can be made between the amount by which prices fluctuate and the lead time between the establishment of the price and the date of the eventual transaction. It is possible to have an elaborate and sharply changing pattern of price variation settled upon long in advance or to have prices that are set at the last minute fluctuate relatively little. Nevertheless, the tendency is for the preset prices to fluctuate less than the reactive prices.
From an efficiency standpoint, whether the price should be predetermined or reactive depends to a considerable extent on the point in time at which the affected decision has to be made and on the information upon which it is based. A price may be thought of as a signal from the price setter to an affected decision maker that is intended to convey information and provide incentive in the direction of efficient choice. If, when a commitment is to be made by the decision maker (for example, whether to install gas- or oil-fired heating equipment), the price setter has more relevant information (about the relative future scarcities of oil and gas), it may be conducive to better choices to have a firm price for the future transaction (the purchase of fuel) set at or prior to this time. In other cases the purchaser as decision maker may have more up-to-date and immediate knowledge of the prospects than the price-setting seller has, or there may be substantial costs involved in the pricesetting seller’s acquiring a corresponding degree of knowledge, converting this into price information, and transmitting this information to actual and potential buyers (as in the case of variations in demand due to weather conditions or special events). In such cases the determination of prices according to criteria agreed upon in advance but dependent on demand and supply conditions as experienced may be more conducive to efficient allocation of resources. Similar considerations apply, mutatis mutandis, to the relatively rare cases in which the buyer is the effective price setter.
The principal objection to ex post pricing is that it subjects the parties to uncertainty as to the price that will eventually be paid. In some cases this is serious enough to be a major consideration. For example, there is a reluctance to offer gas rates reflecting low current costs of incremental gas use for house heating where it is possible that the costs may rise in the future as the capacity of existing mains becomes fully utilized or supplies of natural gas become more difficult to obtain. It would, of course, be possible to offer the current low rate and to avert overinvestment in gas appliances by adequately notifying purchasers of the likelihood of future price increases. However, given the strong promotional orientation of most customer relations, it might be difficult to insure that an unbiased appraisal of future prospects would be conveyed to customers. This difficulty could be met by means of long-term contracts covering the purchase of a given amount of service at a suitably varied sequence of rates. If the customer is eventually allowed to use more or less than the stipulated amount of service, with the difference adjusted on the basis of ex post rates, undesirable constraints on actual use would be avoided. In effect, the customer protects himself by a kind of futures contract against the income consequences of adverse price changes without precluding appropriate substitutions; however, the administrative problem of adapting such contracts to the needs of individual consumers in a context of utility regulation appears formidable.
Actually, fuel clauses in electric power contracts are a mild form of reactive pricing; these serve, however, more to protect the utility against fuel cost increases than to influence consumption patterns appreciably.
In some cases the strength of the commitment in advance to the use of the service at a given time is slight for a substantial part of the demand while the possibilities for effective short-notice reactive pricing are good. For example, it is quite easy to inform telephone users when they place a call what the current rate is. An actual practice approaching this is that of having different rates for different degrees of priority, the caller being able to ascertain from the operator the expected delay for the various categories. Taking an example from electric power, the same load signal used by Electricite de France to switch rates according to time of day could be used to vary rates on a reactive basis, simultaneously encouraging the switching on and off of deferrable demands such as water heaters and refrigerators. One or more “emergency” steps in a reactive price structure can serve as a substitute for arbitrary physical load shedding and can aid in preventing or mitigating the effects of major power failures.
But whatever the analytical attractiveness of fluctuating and reactive prices, consumers are often found to have a marked preference for predetermined and even flat rates. Thus, for residential telephone service it is found that customers often seem to prefer a flat monthly rate to a charge varying with use, even in instances where the bill for the amount of service actually used would be lower. That flat rate service saves the expense of recording and billing for local calls is in some cases an adequate justification on the cost side for the flat rate. However, in addition to and independently of this, on the demand side customers appear to be willing to pay extra, on the average, for assurance that they will not be faced with an unexpectedly high bill as a result of a spate of high calling activity. In some cases this attitude may arise from a budgeting situation in which a fixed income is heavily mortgaged for relatively fixed outlays, but it also appears to indicate a more general desire to be free from worry about the economic consequences of actions. If so, many would regard this as a legitimate preference of consumers to be given appropriate weight in decisions about price structure.
In some markets the price to consumers is made reactive through the intervention of speculators. Where the supplier of a service feels constrained to adopt a fairly rigid price policy, whether through custom, excise tax regulations, or a fear that price concessions might be thought to indicate an inferior quality of product, as with theater seats, speculators often find it profitable to pre-empt the units most in demand and resell them at higher prices. To the extent that demand is thus diverted from those less eager to those more eager for the service, as measured by the price they are willing to pay, speculators can be said to enhance the value of the service rendered and, hence, to be productive. However, because of the disorganized and often clandestine nature of their operations, their costs may often exceed the value of the enhancement, so that their net productivity becomes negative. The possibility that a well-coordinated and efficient market in reserved seats for sporting events, theatrical performances, long-distance air travel, and the like might prove highly productive is not to be ignored. Or such reservations might be sold originally on a basis that would simulate the action of such a market: at any given date in advance of the performance, reservations would be sold at prices varying according to the relation between the proportion of the seats of the given category still unsold and the time remaining to the date of the performance. This is, in effect, a form of marginal-cost pricing, marginal cost being in this case the expected value as of the current instant of the seat to the potential purchaser eventually displaced as a result of the current sale (adjusted, possibly, for changes in the identity of other purchasers). While marginal cost in this sense cannot be defined independently of the price policy in the succeeding interval, there will in general exist a price policy such that the price at any given instant corresponds to expected marginal cost computed in terms of the specified price policy. Even though this definition is implicit rather than straightforward, it is still capable of being evaluated to an acceptable level of precision. It is, in effect, merely a formal specification of what would be expected to take place in an efficient speculators’ market.
Another form of speculative pricing occurs in the successive auctioning of highly similar items and in the letting of contracts by sealed tenders, where decisions on how to bid often depend, under the usual procedures, on speculative evaluations of the bidding strategy of others. The efficiency of such procedures can often be enhanced and the results made more nearly Pareto-optimal by departing from the traditional procedures. For example, similar items can be auctioned simultaneously rather than sequentially, or it can be stipulated that the contract being bid for will be awarded to the lowest bidder but at a price equal to the bid of the second lowest bidder. This latter procedure sounds as though it would result in a needlessly high price. However, when allowance is made for the effect of the change in procedure on the level of the bids that rational bidders would make, it is by no means clear in which direction the price will be affected on the average. What is clear is that the improved procedures enhance the likelihood that the items being sold will be bought by those valuing them most highly and that the contract will be let to the bidder expecting to be able to perform it at the lowest cost.
Discriminatory pricing
In the absence of economies of scale, marginalcost pricing consistently carried out would yield revenues sufficient to cover total costs, at least where the level of investment has been appropriate. Most of the more difficult problems of price structure occur, however, in a context of substantial economies of scale, in which case, under a strict application of the marginal-cost rule, revenues would fall short of total costs by an “intramarginal residue.” Earlier advocates of marginal-cost pricing tended to assume that the appropriate procedure here is to cover this intramarginal residue by subsidies financed out of general tax revenues. But with growing governmental budgets has come increased recognition that substantial increments of tax revenues cannot ordinarily be obtained without incurring additional administrative and compliance costs and interfering with the efficient allocation of resources in other ways. This has led to acceptance of the “principle of the second best,” which states that it is desirable, as long as the marginalcost price cannot be maintained in every market, to have prices that generally deviate from marginal cost in complex ways that depend on the complementarity and substitution interrelationships among the various commodities and services.
This in turn implies acceptance of discriminatory pricing. In the simplest case, where the market demands for the several output categories are substantially independent, a rough rule is that the ratio of the cost (in terms of misallocation of resources) of curtailing consumption by one unit to the net revenue so obtained shall be the same in the various markets. The misallocation can be measured by the difference between the marginal cost of production of the unit and its value to the consumer as measured by the market price he pays. The net revenue is the excess of the marginal cost saved by producing one less unit over the marginal revenue given up, marginal revenue being in turn the price of the last unit being curtailed minus the gain from increasing the price of all preceding units. The implication of this rule is that the proportion by which marginal cost falls short of price is to be made inversely proportional to the elasticity of demand. It is to be noted, however, that while this sounds fine in principle, elasticity of demand is notoriously difficult to determine in practice. This principle reintroduces, in a more restricted form, the discrimination often stigmatized as “charging what the traffic will bear.”
Where products or services are close substitutes, a different consideration comes into play: the desirability of keeping the price relationship between the two goods or services in line with the relationship of marginal costs, so that a customer making a choice between the two will be faced with a price differential that properly reflects the difference in marginal cost. This poses a special problem where the competing products or services are produced under sharply differing degrees of economy of scale, as when an all-rail route competes with a route making use of coastwise shipping. The allrail route may well be unable to attract the share of the total traffic that can most economically be moved along it unless this route can quote especially favorable rates that will make little or no contribution to covering the intramarginal cost residue, or unless rates for the water movement are kept artificially high by taxes or by high rates for the complementary rail segments of the route. If the water route rates are kept high, this may, on the other hand, unduly inhibit the movement of traffic by water even where an all-rail movement is entirely out of the running. Competition among the varying modes is indeed one factor that has contributed greatly to the complexity of freight tariffs.
Where the degree of economy of scale is more nearly the same, as when two rail routes compete, the problem tends to be less one of introducing needed discrimination than one of avoiding discrimination arising from cutthroat competition. In the absence of regulation, in extreme cases rates between competing termini have been brought substantially below rates between intermediate points. Such rate structures obviously interfere with the efficient location of industry; and there is, accordingly, a tendency to try to curb this kind of price competition within a single mode of transportation while opening the door a little wider for competition between modes. One result has been the adoption of flat blanket rates for entire areas or zones, in part to simplify rates generally but also as a way of making it easier to recognize and inhibit attempts to undercut competitors by rate concessions. The possibility of competitive improvement in quality remains, and is at times carried to wasteful excess; but improvement in quality is a slower and more difficult process, less likely to result in a major impairment of over-all net revenues. Blanket rates, however, often mask significant differences in marginal cost for transportation to or from different points within the blanketed area, or by different routes to the same point, and thus in their turn lead to inefficient routing of traffic and location of activity.
Highway competition has been a strong factor tending to break down discrimination based on commodity classification where rate differentials were based on the supposed elasticity of demand rather than on characteristics of the commodity related to cost of transport, such as density or susceptibility to damage. To avoid losing highly profitable traffic to highway trucks, railroads have been forced to reduce premium rates formerly charged on high-value goods and to place greater emphasis on “all commodity” rates, particularly in the case of shipment in containers and in highway trailers carried on flatcars. The highway competition problem is further complicated by the fact that trucks share the burden of the intramarginal residue of highway costs with other highway users.
Aside from the need , to stabilize competition, geographical uniformity of rates, even in the face of significant differences in cost, has great appeal to management on grounds of administrative simplicity and to the general public on grounds of equity. Indeed, such uniformity often masks more or less deliberate discrimination. Thus rural electric service or postal service at uniform rates may reflect a more or less conscious desire to redistribute income in favor of agriculture.
Another type of discrimination in the guise of uniformity arises when delivered prices are quoted on a uniform basis, with the seller absorbing differences in transportation cost, rather than on a “mill net” basis. In some cases this is merely a matter of ignoring, for the sake of convenience, costs that would make only a minor difference in the total bill. But the practice often goes further than this and constitutes a recognition that sales to more distant customers are subject to stronger competition from other suppliers than sales to nearby customers. This discrimination has been carried further still in “basing point” schemes, in which the delivered price includes freight, not from the shipping mill but from an established basing point that may approximate the location of a competitor’s mill. In international trade, the practice of selling to a more remote market at a lower net realization than is obtained from domestic customers is referred to as “dumping” and is often strongly resisted by the customer country through tariff and other measures.
Where the use of a system supplying services involves some form of physical connection or semipermanent relationship between customer and seller, additional opportunity arises for discriminatory pricing through various forms of “multipart tariff.” To be sure, where there are costs associated with the connection as such, it is often difficult to distinguish the discriminatory aspects of such schedules from the cost-related aspects. In electricity supply, for example, there is good justification, on strictly marginal-cost principles, for a “customer charge” related to the installed capacity of the connection to the system and covering the cost of this connection plus meter-reading and billing costs. In addition, the user would pay energy charges, which may vary according to time of day and season of the year, and charges for “wattless KVA” drawn by motors and other inductive devices, which may also vary by time of day, but not in the same way as the energy charge. Where time-of-day rates are deemed impractical, because of high metering costs or for other reasons, recourse may be had to step rates, which charge for successive blocks of monthly energy consumption at successively lower rates. Attempts have been made to justify this practice on the ground that customers using only energy in the first blocks draw a relatively large proportion of their energy in the peak periods. A more realistic appraisal seems to be that this represents mainly a discriminatory exploitation of differences in the elasticities of demand for the various blocks of power. Among domestic users, this discrimination operates regressively in favor of the larger customers, who tend to have the higher incomes.
It has been suggested, indeed, that the size of the blocks should be varied according to the size of the premises served, but this practice has not proved popular. Not only would it tend to correct the regressive impact of the more usual type of schedule, but it might, properly adjusted, put nearly all customers at a point on the schedule where they could obtain additional energy at marginal cost, so that the efficiency conditions could be met much more closely. However, if the total charge varies with the size of the premises, this converts the rate schedule into a charge on space at the margin and leads to an uneconomical stinting in the use of space instead of uneconomical stinting in the use of power.
On a strictly cost basis, however, there is considerable justification for a charge based on lot area or street frontage, representing the cost of carrying the conduits past the property. Efficiency considerations suggest that such a charge could properly be assessed against any occupant of land within the service area, regardless of whether the specific service is taken, on the ground that occupancy of space in an area in which the service is provided increases the cost of providing the service to those who need it. While charges of this type are sometimes used for water supply, they have not been much used for other utility services, although in some instances developers of new residential areas have been required to provide or pay for a portion of the utility distribution plant.
The direct effect of such charges on the allocation of resources is likely to be somewhat independent of the exact method of computing the charge, since any variations from one method to another would probably be capitalized in the value of the affected land. Indeed, the effect of such charges would in the long run not be very different from giving the agency providing the service a general subsidy financed by land taxes (as distinct from taxes on improvements) imposed on the property in the service area. The crucial element is that the amount of the tax or charge be independent of improvements or changes in the nature of the use of the property. In some jurisdictions, indeed, liability for property tax is made conditional on the availability of specified municipal services, such as garbage collection, although in most cases the tax is assessed on improvements as well as on land. There would, in principle, be no need to restrict such charges to cases where the distribution system comprises fixed capital plant: mail and parcel delivery service would be cases in point.
Even in the absence of an individual physical connection, or where rate blocks of uniform size would be too arbitrary, a form of multipart pricing is sometimes effected by a variant of the “requirements” contract, in which the shipper, in return for a more favorable set of rates, agrees to ship or receive not less than a given percentage of his total shipments via the specified carrier or mode, usually rail. Such bahntreu rates differ in motive from the block rates for electric power, however, in that they usually are aimed at diverting traffic from competing modes rather than at increasing the total volume of traffic moved.
Complex as pricing policies already are, modern technology is opening new areas for pricing as a means of enhancing efficiency. Until recently it has been considered impractical to make specific charges, for example, for the use of city streets, and from time immemorial the attractiveness of the city core has resulted in the growth of traffic until the costs of congestion have inhibited further increase. The obvious wastefulness of this congestion has led to recent attempts in England and elsewhere to devise methods of assessing charges on the users of the congested streets that would bring home to them the costs that they impose on others by their presence in the congested area, and thus would restrain use to that which is sufficiently urgent to warrant occupancy of the scarce space. In this way it is hoped that the economic productivity of the core street area will be enhanced much as the enclosure of common agricultural land led to an increase in agricultural productivity.
Even when prices are not actually charged, “shadow prices” are being increasingly used as a management tool in large complex organizations as a means of decentralizing the decision-making process. Such uses have been given considerable impetus by the fact that similar “shadow prices” emerge as an integral part of the process of solving linear programming problems. These shadow prices have the property that when the various activities being analyzed are evaluated in terms of them, all activities carried on at positive levels in an optimum solution will show a zero profit, no activity will show a net gain, and in general, activities that cannot be a part of any optimal solution will show a loss. In this and other ways, even socialist and centrally planned economies are finding increasingly that proper pricing policies can play a crucial role in the efficient organization of an economy.
William S. Vickrey
[See alsoTransportation, article on Economic aspects.]
BIBLIOGRAPHY
Bonbright 1961 is an excellent recent summary of pricing as applied to utilities; Davidson 1955 goes into further details which illustrate the tortuous reasoning often resorted to in this area; while Ripley 1912 provides a contrasting statement of the practices typical of an earlier era. Lerner 1944 sets forth in fairly simple form the logicof the more general role of prices and pricing policies in the efficient allocation of resources; Hotelling 1938, a somewhat more mathematical presentation, is of special interest as having stimulated a new level of interest in the problem of pricing in cases involving economies of scale. Ruggles 1949; 1950 provide an excellent summary and documentation of the theoretical discussion up to 1949; Beckwith 1955 gives a more elaborate critique of the de velopment of the theory and adds some suggestions on how the principles can be applied in a variety of concrete situations. Great Britain … 1964 discusses the possibilities and the problems involved in applying pricing methods in a hitherto largely unpriced situation, while Boiteux 1956 illustrates the skillful use of highly theoretical tools by an author having practical experience and responsibility.
Beckwith, Burnham P. 1955 Marginal-cost Price–Output Control: A Critical History and Restatement of the Theory. New York: Columbia Univ. Press.
Boiteux, Marcel 1956 Sur la gestion des monopoles publics astreints a l’equilibre budgetaire. Econometrica 24:22–40.
Bonbright, James C. 1961 Principles of Public Utility Rates. New York: Columbia Univ. Press.
Davidson, Ralph K. 1955 Price Discrimination in Selling Gas and Electricity. Baltimore: Johns Hopkins Press.
Great Britain, Ministry of Transport 1964 Road Pricing: Economic and Technical Possibilities. London: H.M. Stationery Office. → A report of a panel set up by the Ministry of Transport, with R. J. Smeed as chairman.
Hotelling, Harold 1938 The General Welfare in Relation to Problems of Taxation and of Railway and Utility Rates. Econometrica 6:242–269.
Lerner, Abba P. 1944 The Economics of Control: Principles of Welfare Economics. New York: Macmillan. Ripley, William Z. (1912) 1927 Railroads, Rates and Regulation. New York: Longmans.
Ruggles, Nancy D. 1949 The Welfare Basis of the Marginal Cost Pricing Principle. Review of Economic Studies 17, no. 1:29–46.
Ruggles, Nancy D. 1950 Recent Developments in the Theory of Marginal Cost Pricing. Review of Economic Studies 17, no. 2:107–126.
Vickrey, William S. 1963 General and Specific Financing of Urban Services. Pages 62–90 in Conference on Public Expenditure Decisions in the Urban Community, Washington, D.C., 1962, Conference on Public Expenditure Decisions in the Urban Community: Papers & . Edited by Howard G. Schaller. Baltimore: Johns Hopkins Press.
II PRICE CONTROL AND RATIONING
Freedom from personal control by government is deeply imbedded in the ideology of enterprisemarket economies. This freedom as it applies to the individual market decisions which determine prices and purchases in such economies finds strong functional support in the economizing role played by free prices. In the Western democracies, and notably in the United States, government control of industrial and commercial prices and government rationing of goods have traditionally been resorted to only in periods of war or near-war.
The economy of the United States, although characterized by considerable government activity and influence, is essentially an enterprise-market economy, the logic and operation of which call upon prices to play a central economizing role. It is of the very essence of this role that prices be free to respond to, and continually to reflect, the myriad choices and decisions of individual consumers and producers as these are meshed together in the market, and, in turn, continually to guide these choices and decisions.
Role of price in enterprise-market economies. Buyers, as they bid in free markets for the con sumer-good offerings of sellers, sit in review on the decisions which producer-sellers have made as to the uses of the economy’s scarce resources. The prices placed on consumer goods represent market evaluations of these goods and, hence, of resources put to these uses. Producer-sellers in their turn have bid in free markets for these resources (factors of production). The prices (costs of production) which they have paid in hopeful anticipation of later favorable judgments by con sumers represent market evaluations of the re sources.
When the price which emerges in the market for a consumer good is below its cost of production as determined in intermediate and factor markets, it means a pecuniary loss for the pro ducer-seller. More fundamentally it bespeaks the market judgment of consumers that the economy’s resources have been misused—resources of given value have been misdirected into uses of lower value. On the other hand, a price above cost of production means a gain for the producer–seller and a market verdict by consumers vindicating the producer’s resource decision—resources of given value have been transformed into goods of higher value. The gains, prospectively and as realized, encourage resource decisions in line with society’s desires as reflected in free markets; the losses deter and prompt corrections of decisions which misallocate resources.
The prices worked out in the markets for th basic factors of production—land, labor, capital, and enterprise—constitute not only the basic costs of production but also the incomes of all who par ticipate in production, the incomes which enable them in their capacities as consumers to bid effectively for goods to satisfy their desires.
The constant interplay of prices, as they respond to and influence demands and anticipations within and between the markets for consumer goods, in termediate goods, and basic factors of production, is the enterprise-market economy’s mechanism for directing the employment of its scarce, valuable resources and for distributing the fruits of production among those who participate in production. It is the process by which such an economy economizes. It is not surprising, then, that in economies or sectors of economies where prices traditionally are cast in the leading economizing role, doubts are raised by suggestions for government controls designed to limit the free market interplay of prices or to substitute government for prices and the market in the performance of the economizing function.
Price control in enterprise-market economies. Principal reliance by enterprise-market economies upon free markets and free prices to perform the economizing function has not meant exclusive reliance upon these forces, even in the absence of war or preparation for war. The classic instance of generally accepted peacetime price control occurs in the case of public utilities, where, because of peculiar economic and physical features of the industry, competition cannot be relied upon to produce socially acceptable results. Almost universally, where public utility services are provided by private companies, monopoly is established by public authority, and service and price are subjected to government regulation [seeRegulation of industry].
Elsewhere in the economy, too, in particular areas at particular times, dissatisfied groups have succeeded in having the economizing results of free market processes altered by the introduction of government controls of output or prices or both: agricultural price supports, petroleum prorating, and resale price maintenance are examples. In transportation a most confused melange of regulated prices and market prices has developed. At the moment the future of price determination in the transportation industries is most uncertain [seeAgriculture, article onPrice and income policies; Resale price maintenance; Transportation, article onEconomic aspects].
All enterprise-market economies have substantially altered the patterns of income distribution produced by the free pricing processes of their markets—by tax measures designed to take more from the rich than from the poor and by the free provision of public goods which if available only on the market could not be bought widely by persons of low income. Increasingly, governments have taken responsibility for spurring their lagging economies into fuller use of resources and the production of increased national income—by resort to tax, debt management, and public expenditure programs, all of which are intended to effect their results through market prices. Concern over peacetime inflation has stimulated government activity designed to keep the general level of prices in check. This typically takes the form of broad fiscal and monetary (including credit) measures. But more recently informal government pressures, such as admonitions to be “responsible” addressed to industry and labor leaders, have been applied to prices and wages in particular industries. In these instances, control of prices and wages is explicitly disavowed, but, of course, government action here is meaningless unless specific prices and wages are in fact affected.
Despite these instances of direct or indirect price control by government, it remains true that in the American peacetime economy prices are largely left free to work themselves out in markets at all levels and so perform, with greater or lesser success and acceptance, their appointed economizing role. There are, indeed, substantial misgivings in the minds of many about the performance of market prices as guides to resource use and as determinants of factor income—growing out of anterior misgivings as to the actual effectiveness of market competition in eliciting responsive prices. Action prompted by these misgivings, however, takes the form of government programs to restore, rehabilitate, and maintain competition rather than to operate directly on the prices themselves.
Against this background, we may turn to a consideration of the very special circumstances under which even enterprise-market economies undertake widespread programs of price control and rationing, the nature of the programs on which they embark, and some of the problems which they encounter.
Price control in wartime
Price control and control of the distribution of consumer goods (rationing) are parts of over-all government programs to bring about widespread mobilization of economic resources in time of war or preparation for war. They are designed both to help in mobilization and to protect the economy from certain adverse effects of mobilization. Price control and rationing rarely make an appearance except in the company of other war-mobilization controls, and they can be understood and appraised realistically only in this context.
Total, all-out war demands all-out controls, including the allocation of resources and materials, the control of specific prices, and the rationing of specific goods. Preparation for war (“defense”) calls for a program of controls appropriate to the scale of mobilization being undertaken, a program which may or may not include full-blown allocation, price control, and rationing. Both the dangers of inflation and the need for direct controls as instruments for mobilizing resources are less in defense periods than in time of war, and the dangers of (and potentially to) these controls are greater. This is particularly true if it may be anticipated that the defense period will lengthen into an endless era of cold war. Formal direct controls, which are virtually inevitable in wartime, are decidedly optional as measures of long-drawnout preparation for wars which may or may not materialize.
Total war calls for total economic mobilization —a rapid, massive shift of manpower, equipment, and materials from the uses of peacetime to the purposes of war. It demands the utmost in total production despite the transfer of millions of men from fields and factories to military service, and, notably, it demands a cutback in the production of consumer goods in favor of vast new programs for the production of military goods and services. These shifts in resources cannot be made on the scale and at the speed demanded if reliance is had solely upon the ordinary processes of the market. Men will not leave civilian employment by the millions to join the armed services in response to considerations of economic gain. Plants will not be converted en masse and overnight from the production of consumer goods to the production of goods for war (with all that is entailed in new construction, retooling, and the disruption of production and sales contacts and channels) by the precarious directions and questionable lures of early wartime markets. Economic responses would at best be no more certain than the diffused economic calculations on which they were based, and the prosecution of wars cannot wait upon the outcome of speculation, titillation, and gentle persuasion. Sterner and more certain measures are called for. Economic incentives may still be employed, but they must be supplemented by specially designed interventions and by commands. Government limitations on consumer buying and on nonwar uses of resources, and government direction of the use of men, materials, and equipment must take the place of or supplement government bidding in the market in competition with civilian producers and consumers.
A declaration of war is a declaration that the individual economic preferences of the citizens of a country are to be subordinated to what is essentially a single national economic purpose—mobilization of the economy to win the war. Tremendous reallocations are necessary, and time is of the essence. It is of the nature of war that commands which must be obeyed take the place of inducements which individuals are free to accept or ignore and, further, that the operation of commands must not be weakened and diffused by the activities of individual buyers and sellers exercising personal preferences in the market. Markets simply cannot provide the unified direction, speed, and sweep which war demands of an economy. Commands will frequently blunder, and imbalances and unnecessary inconveniences will constantly occur, but the main drive of mobilization cannot safely be entrusted to any mechanism other than centralized command.
Feasibility
A major contention of those who look upon wartime price control and rationing with disfavor born of something more than sheer ideology or purely personal irritation is that these direct controls cannot be made to work—that only confusion and breakdowns can result. Experience indicates, however, that for periods running for at least three or four years, under crisis conditions and admittedly in greater degree for some goods in some markets than for other goods, direct controls can, indeed, be made to work. It is clear, of course, that “frozen” prices cannot perform the allocative role prescribed for prices by enterprisemarket economies. But allocation of materials and rationing are present to perform this task in time of war—devices specifically designed to achieve the special allocative ends which wars require both in the military and civilian sectors of the economy. Those responsible for wartime controls are fully conscious of the allocative role of prices in time of peace and the need, if wartime prices are to be fixed, to establish specific measures to provide for allocation. But it is fair to suggest that they are also concerned to establish allocative measures in their own right and on their own merits as necessary under wartime conditions—even if prices were not to be controlled. Materials allocation and rationing are, to be sure, supplements to price control; they also have a wartime raison d’etre of their own.
The imposition of price control upon the price structure of a modern industrial economy is in itself not as great a shock as some might anticipate. Peacetime markets as we know them are shot through with conditions, conventions, and customs which make it entirely possible to impose government controls under the circumstances of war without great fear that a highly sensitive, marvelously articulated mechanism will, by the very fact of intervention, be destroyed and without great apprehension that the mechanism simply cannot be made to function under other than its own internal forces and controls. To be sure, some markets are more amenable than others to unusual external controls whether of prices or distribution, and equal success cannot be expected of controls imposed in all markets under all circumstances. Controls need to be tailored to conditions—and in some instances should not be imposed.
However, in many industries and markets, sellers consist of (or are led by) a few large firms. What we know of these markets suggests that prices are made more by the personal decisions of the few than by impersonal forces of the market. Such prices can be controlled by government with much greater ease and with much less impairment of any impersonal allocative function they may be thought to perform than would be the case if in peacetime they were the product of more completely competitive processes. We have been reminded by J. K. Galbraith that it “is relatively easy to fix prices that are already fixed” (1952, p. 17). In World War II, the American economy, operating under a network of direct controls calculated to mobilize, redirect, allocate, and distribute resources and goods, changed its course drastically from peace production to war production and consumption, and picked up speed and productive power in the process.
Necessity
Inflation is a normal consequence of large-scale mobilization. Total national product and, hence, total national money income may be expected to reach new highs, but much of the product (anywhere from 40 to 60 per cent) must be for military rather than civilian use. Military demands added to the demands of newly enriched consumers for goods and, hence, for the means and materials of production can result only in greatly elevated prices, unless countermeasures are taken. Simply stated: higher than usual personal incomes in pursuit of a lower than usual output of personal goods can be balanced in the market only at new, higher price levels.
However, consumer demands can be partially curbed. Much personal income can and will be extracted from civilian pockets by increases in wartime taxes and by vigorously conducted sales of wartime government bonds to individuals and businesses. As an academic matter, enough purchasing power in the aggregate could be transferred by these measures from the civilian population to match the transfer of resources from civilian to government military uses and, hence, to permit the balancing of civilian demand with the lowered output of civilian goods with no increase in the general level of prices.
In the actual event, however, this will not be done and for good reason. Government borrowing from individuals and businesses is a fruitful source of wartime funds, but at best it will produce far less than the amounts required, and its proceeds are uncertain. If the government is to obtain by taxation the rest of the vast sums it needs, it must levy its taxes where, at the moment, the money is located. Any such tax program, geared to the tremendous demands of an all-out military effort, would necessarily violate all canons of equity in taxation. It would, as well, ruin any plans the government might have to employ economic incentives as part of its mobilization program.
Granted that governments could and should undertake to support wars by greater dependence upon taxes than they typically find to be politically feasible, it is generally conceded that they are wise not to go all the way in adopting a payas-you-go program of war finance. It is even more certain that they will not in fact go all the way. Deficit financing, in greater or lesser measure, with its attendant threat of inflation is one of the realities of war [seeFiscal policy, article ovWartime fiscal policy],
The fact is that if inflation is to be prevented— even if only suppressed or contained—broad indirect measures, such as taxation, public borrowing from individuals and firms, and monetary and credit controls, will have to be supplemented by direct government control of specific prices. This would still be true even if the so-called inflationary gap could be largely wiped out by taxes and bond sales. Panic buying and speculative buying of strategic materials and key commodities could produce skyrocketing prices and profits, which could create bottlenecks and threaten the success of economic mobilization. These increases could lead in turn to spiraling wage demands and further price increases both in the immediately affected and in other commodities. This would be certain to occur in industries where the ineffectiveness of competition leaves much room for discretion in the setting of prices and wages—where increases in both could easily be passed on. Latent savings and credit could feed the fire, and no government concerned with winning a war could avoid further deficit financing. As Donald Wallace put the matter, “In full war, the question is not whether inflation can be stopped without use of direct controls but whether inflation can be checked even with the greatest practicable use of all controls, direct and indirect” (1953, p. 16).
Supporters of wartime price control are quite willing to concede that its effect is to suppress inflation and not fully to destroy its underlying causes, but they argue that suppressed inflation is to be preferred to open inflation, that the excess demand contained by price control itself serves a useful wartime function, and finally that suppressed inflation can be rendered “noninflationary” by the use of proper fiscal, credit, and control measures during a reasonable liquidation period following the war. It is pointed out that the price controls which suppress inflation operate on particular prices so that price-wage spirals will not be touched off and the war economy will thus be immunized from a particularly virulent and destructive form of inflation. Excess demand, stored up behind the controls guarding the prices of consumer goods, far from indicating weakness or lack of sophistication in the application of fiscal and price controls, should be regarded, if properly administered, as a most useful tool for the development of maximum economic–military potential. It is “a practical way of adapting modern capitalism [by facilitating the absorption and employment of great increases in the labor force and in the use of labor]—a capitalism characterized by oligopoly in product markets and strong unions in factor markets—to the wartime imperative that all possible resources be employed and if possible under approximately stable conditions of prices and costs” (Galbraith 1952, p. 34). Restraint in the removal of price controls following the cessation of hostilities, and the employment of budget surpluses coupled with restrictions on consumer borrowing and new investment, could thin out and gradually reduce inflationary pressures to the point of elimination.
Rationing. Rationing of consumer goods is the naturalally of price control. It will certainly be called up for wartime service. All-out war is bound to bring at least limited rationing, and if price controls are widely extended, rationing, too, will spread. In peacetime enterprise-market economies, rationing (the distribution of goods) is a function of price; in war economies price control and rationing provide each other with much-needed support. The case for both rests on the limits that war places on the aggregate supply of consumer goods, while aggregate consumer purchasing power continues to rise, as well as on the fact of particular shortages in particular markets. Rationing can be made to check consumer demand and thus to eliminate pressure on prices. It can contribute to the equitable distribution of essential goods in short supply. (Note that under war conditions our notions of equity undergo something of a change.) Rationing can direct particular scarce goods where they are most needed for war purposes, and it is a natural complement to and support for government orders that limit consumer use of scarce materials. Experience in World War ii demonstrated the need for rationing for all of these purposes in the case of such commodities as rubber, petroleum, metals, sugar, and meat and other foods (see Wallace 1953, pp. 215 ff.). Rationing was particularly necessary as a support to price control in those highly competitive markets where price control was subjected to great pressures.
Policy and administration
The introduction and operation of price control and rationing involve important policy decisions as to timing, coverage, and type of control and as to administrative machinery and personnel.
Policy
A price or prices may be “frozen” at the level of a given base date or during a given base period. This is the most dramatic type of price action, and it may be employed for this very reason in the presence of an immediately threatened increase or spiral of prices. It presents many difficulties, both of compliance and enforcement, most of which grow out of lack of knowledge by sellers and buyers of actual base prices. It always embodies inequities that must be corrected over time, and it leaves open the problem of new commodities and new types or styles. Legal maximum prices may be calculated by formulas, a useful procedure in the case of special commodities and a necessary procedure where new goods or styles are involved. Again, however, buyers are not in possession of the information necessary for really effective enforcement. Margins or markups fall into this category, and these may or may not be effective in holding prices, depending upon the character of the calculation of the cost base to which they are applied. For compliance and enforcement, no other type of ceiling can equal published or publicly displayed dollar-and-cents prices, and if price control programs are long continued, such lists are bound to become more prevalent.
Selection of the goods to which price control is to be applied presents a difficult problem. Certain goods are natural candidates for control because of spot-price situations (speculative or panic buying), because price control is needed as an aid to production control, or because the goods (costof-living or “wage” items) are likely to contribute to price-wage spirals. As suggested above, it is easier to control the prices of standard goods produced and sold under conditions of oligopoly, where sellers are few and peacetime prices are “administered,” than the prices of goods which are subject to frequent changes in type and style or which are produced and sold by a multitude of small firms, which typically “follow the market.” The case for control of the prices of luxury (“nonwage”) goods rests not so much on concern for their users or because of their direct effect on inflation as on the likelihood that high prices, profits, and wages in these industries will attract resources from, and instigate inflationary demands in, other industries.
Considerations relevant to control in particular instances are frequently in direct conflict. The need for control of food prices is great, but so are the difficulties of control. One consideration that is likely to impress price controllers as the control program continues is that all prices are interrelated. While this fact does not dictate an all-ornothing coverage, it points up the need to be on the lookout for unanticipated effects and is a powerful force moving for an extension of controls, once instituted. Woe to the controllers, for example, who fail to keep the price of hogs in mind when setting the price of corn.
It is necessary to establish price standards if control is to involve more than a freezing of past prices, and even frozen prices have to be adjusted to reflect individual circumstances and unique conditions. Prices must be set de novo for new goods and goods offered by new sellers. And prices once fixed may need to be changed because of consideration of equity, expediency, or changed conditions. It is fashionable to contend that it is prices not profits that are being controlled; but effect on profits cannot be avoided, and there is much to be said for tying price control directly and openly to, say, percentage return on net worth. It is inevitable as the program grows that particular prices be tailored to particular, identified purposes—the removal of disparities and inequities, the bolstering of physical controls, the meeting of shortages. In some instances involving strategic materials, carefully tailored and differential prices may have to be supplemented by subsidies to insure needed production. The function and effects of prices are nowhere more clearly apparent than in a program of price control once gotten under way.
Rationing. Rationing, too, calls for decisions on types and coverage. The intricacies and the sheer physical task of rationing are, if anything, greater than in the case of price control. A strong case can be made on paper for the wide extension of rationing. The realities of the task, however, counsel the restriction of rationing to those instances where great shortages of very important commodities are involved or where the greatest importance attaches to the placing of particular goods in particular hands. Certificate rationing provides a ticket for each allotment, awarded (as in the case of tires in World War II) to persons on the basis of their specifically determined need for the commodity in relation to the war effort. Coupon rationing entitles the coupon holder to buy a stated quantity of a given good (for example, sugar) at any time during a given period. Point rationing covers items which are more or less substitutes for each other (for example, different foods), and it entitles the holder of point coupons to distribute his limited purchases as he pleases over a range of goods. This device makes it possible to change point values as supplies and demands change and hence to adjust distribution to changing conditions.
Consumers are bound to be disappointed at the limited amounts they are permitted to buy legally, and the temptation is great for rationing officials to overextend their issuance of certificates, coupons, or points. Nothing, of course, could be more damaging to a rationing program, and few things could be more directly damaging to civilian morale and to the war effort. Coupons as a condition of buying are irritating enough; coupons “without honor” compound the irritation.
Direct control of specific prices is, quite understandably, not popular with sellers, both because of its effect on revenue and the irritations which are produced inevitably by its imposition and administration. Rationing of consumer goods is, if anything, even more unpopular with sellers and consumers. The latter, almost universally, see its restrictive rather than its “fair share” aspect; it appears to them to be rationing rather than the war that is responsible for their inability to buy all of any good they are willing to pay for.
In time, as these controls become more widespread and come to be associated in the public mind with all of the inconveniences of war, the unpopularity fans out generally over the population and deepens in intensity. There can be no doubt that it is easier and more comfortable not to be controlled than to the controlled, just as it is easier and simpler not to control than to control. Paradoxically, if the controls prove to be reasonably successful in containing inflation, with the result that the dangers of inflation fade from public consciousness, the need for controls seems less urgent. Their very efficacy undermines public support for their continuance.
Administration
The task of setting up and operating the machinery required to control most prices at all levels and to ration a considerable array of products is staggering. Since these are not regular, continuing functions, the staff must be specially recruited, and the members are bound to be amateurs—learning, it is hoped, as they perform. Some members can be drawn from industry and business, and there is a widespread misconception that because industrial and business prices are involved, industrial and business personnel are peculiarly suited to the task. Quite the contrary is true. Industrial and business knowledge and advice are essential, but price fixing in the context of government control is quite different in con ception, objective, and practice from the making of prices within a business firm. Businessmen, however conscientious, have much to unlearn before they can qualify as government price controllers. University economists come to the task better prepared than most, but they suffer from the allegation, sometimes justified, that they are unrealistic crusaders. The fact is that there is n professional career in an enterprise-market economy for the price controller and rationer, and, hence, there is no standby staff.
Other administrative problems, too, are almost overwhelming: control by Washington versus control by the field offices; simple regulations in th interest of understanding and compliance versus detailed regulations in the interest of precise tailoring to fit individual situations; toughness and rigidity versus sympathetic understanding and flexibility. These and a myriad other issues are always present—and, in actual cases that make a difference, not just in a broad philosophical setting. And congressmen, whose constituents “don’t like it,” are omnipresent and insistent. In due course controllers as well as those controlled will have had their fill.
Increasingly it is borne in on everyone that there is in fact a basic difference between being controlled, commanded, and even abused by th cold, heartless, impersonal forces of the market and by the personal orders (however understanding and “correct”) of government officials and that at this stage in history democratic peoples seem to prefer unidentified systems to identified officials as economic arbiters. As price control and rationing proceed, the scales on which the public in democracies weighs the disadvantages of inflation against the irritations of controls are almost certain eventually to swing in favor of “kick out the controls.” But it is equally certain that at another time and with the advent of another national emergency requiring sweeping mobilization of the economy and threatening serious inflation, direct controls will be eagerly and confidently adopted again.
Ben W. Lewis
BIBLIOGRAPHY
The author of this article has drawn heavily upon two books by economists who were deeply involved in the planning and execution of the American program of price control and rationing in World War ii: Galbraith 1952 and Wallace 1953. Chandler & Wallace 1951 contains an ex cellent bibliography of U.S. Government publications relating to wartime controls in World War i and World War ii. Particular attention should also be called to the 15 publications of the U.S. Office of Temporary Controls 19471948 covering the work of the Office of Price Administration in World War II.
Campbell, Robert F. 1948 The History of Basic Metals Price Control in World War II. New York: Columbia Univ. Press.
Chandler, Lester V.; and Wallace, Donald H. 1951 Economic Mobilization and Stabilization: Selected Materials on the Economics of War and Defence. New York: Holt.
Chicago, University Of, Law School 1952 Defense, Controls, and Inflation: A Conference. Edited by Aaron Director. Univ. of Chicago Press.
Clark, John M. 1944 Demobilization of Wartime Economic Controls. New York: McGraw-Hill.
Economic Mobilization Short of War. 1951 American Economic Review 41:51–84.
The Economics of Preparedness for War. 1949 American Economic Review 39, no. 3:356–383. → A Pro ceedings volume.
Economics of War. 1940 American Economic Review 30, no. 1, pt. 2:317–382. → A Proceedings volume.
Galbraith, John K. 1947 The Disequilibrium System.American Economic Review 37:287–302.
Galbraith, John K. 1952 A Theory of Price Control.Cambridge, Mass.: Harvard Univ. Press.
George, Edwin B.; and Landry, Robert J. 1950 The Problem of Controlling Resource Flows in Wartime. American Economic Review 40:323–348.
Hancock, William K.; and Gowing, M. M. 1949 British War Economy. London: H.M. Stationery Office.
Hardy, Charles O. 1940 Wartime Control of Prices. Brookings Institution, Institute of Economics, Publication No. 84. Washington: The Institution.
Hart, Albert G. 1953 Defense and the Dollar: Federal Credit and Monetary Policies. New York: Twentieth Century Fund.
Keynes, John Maynard 1940 How to Pay for the War: A Radical Plan for the Chancellor of the Exchequer. New York: Harcourt.
Klein, Burton 1948 Germany’s Preparation for War: A Re-examination. American Economic Review 38: 56–77.
Lewis, Ben W. 1945 Lambs in Bureaucrat’s Clothing.Harper’s Magazine 191:247–251.
Mills, Frederick C. 1943 Prices in a War Economy: Some Aspects of the Present Price Structure of the United States. National Bureau of Economic Research, Occasional Paper No. 12. New York: The Bureau.
Novick, David; Anshen, Melvin; and Truppner, W. C.1949 Wartime Production Controls. New York: Columbia Univ. Press.
Price Control and Profit Control. 1951 Capital Goods Review No. 7.
Price Control and Rationing. 1943 American Economic Review 33, no. 1, pt. 2:253–278. → A Proceedings volume.
Price Control and Rationing in the War-Peace Transition.1945 American Economic Review 35, no. 2:150–192. → A Proceedings volume.
Problems of an Advanced Defense Economy. 1950 American Economic Review 40, no. 2:191–233. → A Proceedings volume.
The Role of Price Control. 1951 Capital Goods Review No.8.
Rosenbaum, E. M. 1942 War Economics: A Bibliographical Approach. Economica New Series 9:64–94.
Taussig, Frank W. 1919 Price-fixing as Seen by a Price-fixer. Quarterly Journal of Economics 33:205–241.
U.S. Office of Temporary Controls 1947–1948 General Publications. Nos. 1–15. Washington: Government Printing Office. -+ No. 1: The Beginnings of O.P.A. No. 2: Ration Banking. No. 3: Apparel Price Control. No. 4: Field Administration of Rationing. No. 5: O.P.A. and Public Utility Commissions. No. 6: Industrial Price Control. Nos. 7–11 [Problems in Price Control]: Standards; Techniques; Changing Production Patterns; Stabilization Subsidies; Legal Phases. No. 12: National Office Organization and Management. No. 13: Studies in Food Rationing. No. 14: O.P.A. Volunteers. No. 15: A Short History of O.P.A.
U.S. War Industries Board 1941 American Industry in the War: A Report of the War Industries Board. Englewood Cliffs, N.J.: Prentice-Hall. → The report was submitted in March 1921 by Bernard M. Baruch, chairman.
Wallace, Donald H. 1953 Economic Controls and Defense. New York: Twentieth Century Fund.
Wilcox, Walter W. 1947 The Farmer in the Second World War. Ames: Iowa State College Press.
III PRICE HISTORY
Although movements of commodity prices can be measured in earlier periods than can any other phenomenon of general interest to social scientists, we have no satisfactory records of prices in antiquity. Sporadic quotations for a few commodities, such as grain, metals, and livestock, in different places give rough ideas, which are valuable for some purposes, of the relative prices of a few articles and of some violent changes in the price level. (Examples of such violent changes are those which the treasure obtained in Alexander’s conquests induced in Greece in the fourth century B.C. and which the debasement of the coinage caused in Rome in the third and fourth centuries.) But there are no series of commodity prices that will permit us to measure changes in their average for any important locality or period in ancient times.
Medieval price and wage movements
Although more numerous and reliable than those for antiquity, the medieval price data now available lack the regularity, continuity, homogeneity, and diversity required for the satisfactory measurement of the price level before about 1350. The next oldest continuous quantitative economic data are money wages, or the price of labor. Despite their obvious importance, wage data have been neglected by some price historians and used with less skill than commodity price series by many others. Nevertheless, we can trace the movements of money wages in many leading economic areas since about 1500, and we can gain a fairly accurate impression of major changes in money wages from about the time of the Black Death (1348–1349). The wage data for earlier periods are generally fragmentary and sometimes questionable. But when proper use is made of the incomparably rich and virtually untouched account books in Italian archives, particularly the Archivio di Stato in Florence and other depositories in Tuscany, our knowledge of prices and wages in the Middle Ages will be vastly enriched and extended.
The preservation of manuscripts that provide the raw material for historical price and wage statistics in one country after another—differing widely in institutions, economic development, and culture—can hardly have been accidental. What was preserved was, and has continued to be, important. Good as they are, however, in comparison with other historical statistics, even the best historical price and wage series are never good enough to satisfy a scholar using them in studying any major problem. Furthermore, the usefulness of the most adequate and reliable price and wage data is usually limited by the lack of other statistical and nonstatistical material that alone can reveal their true meaning.
Index numbers for 50-year periods compiled by Sir William Beveridge (1939) from fragmentary quotations for six commodities show that English prices were about a third higher in 1250–1299 than in 1200–1249 and about 15 per cent higher in 1300–1349 than in 1250–1299. Although he believed that the upward movement of prices was violent, Beveridge was commendably skeptical concerning his results. If the scattered prices thrown together by Vicomte d’Avenel (1894–1926) from different areas of France are reliable, the price level was about 14 per cent higher in 1291–1300 and about a third higher in 1301–1350 than in 1201–1225. Discontinuous quotations (not worth publishing) that I have compiled for a few staple commodities for Aragon and Navarre in 1201–1275 show an upward trend in line with the trend in France. Prices for 12 articles I gathered for Navarre suggest that the price level rose about 25 per cent from 1284–1289 to 1309–1310 but moved horizontally in the next quarter century. Prices for 14 articles I compiled for Aragon indicate that the price level was about 38 per cent lower in 1309– 1310 than in 1276–1277, when money was bad and harvests worse. The index for 1350 was about 6 per cent lower than in 1300. But the underlying data are so scant and questionable that all these estimates of movements of the price level should be regarded as “prehistorical.”
Index numbers of prices in Navarre for 13511380, based on extraordinarily extensive and complete series for such an early period, doubled in terms of money of account and rose 30 per cent in terms of fine gold. The quinquennial average of gold prices collapsed in 1381–1385 and had dropped 7 per cent more by 1441–1445, when the series end. Prices in money of account rose 50 per cent from 1381–1385 to 1431–1435 and fell 7 per cent in the next ten years. Inadequate data for Aragon suggest that prices in money of account doubled in 1351–1380, as they did in Navarre, and declined 17 per cent from 1381–1385 to 1396–1400. The price indexes in money of account averaged about 10 per cent lower in 1426–1450 than in 1401–1425. The average rose about 3 per cent in 1451–1475; but although the quinquennial indexes moved horizontally in 1476–1500, the average for the entire period was about 13 per cent lower than in 1451–1475. The trend of prices in the fifteenth century was downward also in Valencia. Apparently prices in silver averaged about 14 per cent higher in France in the third quarter of the fourteenth century than in the second. Prices fell about one-fourth from 1376–1400 to 1401–1425, and the average for the next quarter century declined about 9 per cent (see Hamilton 1936). In the second half of the fifteenth century, French prices averaged about 24 per cent less than in the first half. The trend of prices in France in the fifteenth century did not differ greatly from the trends in Aragon and Valencia, and the decline seems to have been somewhat greater in Alsace. In the third quarter of the fourteenth century, wheat prices in England —a poor gauge of movements of the price level, but the best we have—rose much more than prices in France but a great deal less than prices in Aragon or Navarre. During the next hundred years the trend of English wheat prices seems not to have deviated greatly from the price trends in Aragon, France, and Valencia. The long decline was apparently followed by a horizontal movement in the last quarter of the fifteenth century. But, as in Aragon, there is no clear evidence of a rising trend before 1500.
Wage rates have been published for Navarre for 10 grades of labor in the building trades in 1346–1400 and 11 grades in 1401–1450. Wage indexes in Navarre, where the Black Death was extremely severe and was followed by secondary epidemics, soared nearly 60 per cent in 1349 and continued to rise irregularly, but sharply, for three decades. From 1346–1350 to 1376–1380 the quinquennial average of wage indexes almost trebled. By the end of the century they had almost quintupled, and by the middle of the fifteenth century, when the series end, they had sextupled. If we divide money wage rates by food prices to obtain a crude index of real wages, we find that the quinquennial average doubled in the half century from 1351–1355 to 14011405. In the next two decades real wages fell about one-fifth, but the net increase in 1351–1445 was more than two-thirds. Crude index numbers of real wages for Aragon suggest that real wages were about one-sixth higher in the last quarter of the fifteenth century than in the first quarter.
For Valencia we have a remarkable series of salaries of 22 classes of workers in 1351–1450 and 25 classes in 1451–1500, together with the wages of 11 grades of labor in the building trades in 1392–1450 and 12 grades in 1451–1500. Salaries rose about 25 per cent from 1355 to 1370 and remained stable for 20 years. They dropped 7 per cent in 1399, but rose 20 per cent by 1418, and remained practically unchanged for 70 years. Salaries then dropped 8 per cent in 1489 and held this level through 1500. Wage rates fluctuated more than salaries, but their trends were rather similar.
Apparently the wages of most types of labor in England rose sharply in the first two decades or more after the Black Death, in spite of vigorous government opposition to wage increases. The rates for the lowest grades of workers may have risen as much as in Aragon, and possibly even as much as in Navarre. Since food prices did not rise substantially, real wages did. Thorold Rogers tells us that although some of the gain was lost, wages never fell to the old rate and that they were stable at a high level throughout the fifteenth century, when prices were falling. He regarded “the fifteenth century and the first quarter of the sixteenth” as the “golden age of the English labourer, if we interpret the wages [which] he earned by the cost of the necessaries of life” ([1884] 1890, pp. 326, 233 ff.). The fragmentary data available suggest that wages also rose substantially in France after the Black Death.
It is often taken for granted that medieval kings robbed their subjects, disturbed economic life, and impeded progress through frequent and unprincipled debasement of the coinage and alteration of its value in money of account. Yet the long-term movement of commodity prices was much more stable in the areas for which we have reliable data in the last two centuries of the Middle Ages than in any country of the Western world during the nineteenth and twentieth centuries. If medieval rulers had not sought to relieve distress and replenish royal treasuries during fifteenth-century depressions by debasing the coinage or marking it up in money of account, prices would have fallen still more. This might have lowered profit margins, deterred savings, and limited progress. For example, in the second half of the fifteenth century Valencian prices fell only about 6 per cent in money of account and a little more than 20 per cent in gold. In the same period prices in Aragon fell less than 10 per cent in money of account and more than 35 per cent in gold (see Hamilton 1936).
It would be extremely interesting to know whether the alternation of debasement and markup of the coinage in periods of falling prices and of restoration and markdown in periods of rising prices, which tended to stabilize price trends, did not also intensify short-term instability by causing changes in velocity opposite to the announced or expected changes in the money-of-account rating or the specie content of the coinage. For example, in Spain not only did merchants overstock goods, but women as unbusinesslike as nuns overbought commodities as perishable as eggs in an effort to avoid losses resulting from royal markups of coins (see Hamilton 1934; 1947).
The Black Death and succeeding epidemics in the next three decades had substantially reduced the population of western Europe and, consequently, the total production of goods when the revival of gold coinage in England, Flanders, Germany, Castile, and Aragon significantly increased the money supply. Hence the price level moved briskly upward. In the last two decades of the fourteenth century and throughout the fifteenth a considerable growth in population, total production, and the proportion of goods exchanged for money lowered commodity prices. The steady loss of specie to the Far East in exchange for spices and luxury products also exerted downward pressure on the price level.
Price and wage history after 1500. Although defective in many respects, price and wage series after 1500 are far more satisfactory than previous series. The data supplied by the archives of Spain are outstanding in quantity and quality. Early in the sixteenth century the trend of prices turned upward in Spain, first and most rapidly in Andalusia, and rose for a hundred years, with practically all troughs and peaks above the preceding ones. Andalusian prices more than doubled in the first half of the sixteenth century and more than quintupled by its close. Prices increased fourfold in New Castile, the region closest to Andalusia, and 3J fold in Old Castile-Leon and in Valencia. On the average, in the four regions prices in silver, then the same as money of account, quadrupled in the sixteenth century. Despite inflation of the vellon coinage (at first copper with a little silver, and then pure copper), which became the money of account after about 1603, the trend of prices in Andalusia, New Castile, and Old Castile-Leon was rather horizontal in 1601–1625; Valencian prices in silver declined slightly. Although there were violent increases and declines in vellon prices for the remainder of the century, the trend of silver prices was moderately downward.
From statistics collected by Thorold Rogers for England and d’Avenel for France, Wiebe (1895) constructed decennial index numbers of prices and wages for England and 25-year indexes for France during the sixteenth and seventeenth centuries. These indexes indicate the direction and approximate magnitude of long-term movements, but are particularly weak in timing changes. Neither Henri Hauser, the latest historian of French prices (1936), nor William Beveridge, the latest and most distinguished historian of English prices (1939), has supplied us with index numbers. Hauser’s data are not extensive or complete enough to measure the price level, and trial index numbers based on Beveridge’s data for 1500–1700 have not shown trends differing significantly from those derived from Rogers.
The decennial price indexes for England were about 6 per cent higher in 1511–1520 than in 1501–1510, more than a third higher by 1551–1560, and about 150 per cent higher in 1593–1602. According to d’Avenel, French prices began rising during the reign of Louis xn, 1498–1512. The French indexes in silver for each quarter of the sixteenth century were higher than for the preceding one, and the index for the last quarter was 150 per cent higher than for the first. Hence, it seems that silver prices rose more in France than in England during the sixteenth century. The decennial average of English prices continued upward in the first half of the seventeenth century, reaching a level in 1643–1652 about 3J times as high as in 1501–1510. The trend of English prices was fairly flat in the second half of the seventeenth century, with the lowest average in 1653–1662 and the highest in 1673–1682.
If we combine the four Spanish regions for which we have data and make 25-year indexes for comparison with France, we find that in each quarter of the sixteenth century the advance over the preceding one was greater in Spain. Comparing decennial indexes for Spain with those for England shows that while English prices were rising 150 per cent from 1501–1510 to 1593–1602, Spanish prices were rising more than 200 per cent. By 1601–1610, when decennial silver prices for Spain reached their apogee during the Price Revolution, they were 3.4 times higher than a hundred years before. English prices reached their zenith during the Price Revolution in 1643–1652, when they were 3.5 times the 1501–1510 level. Spanish prices rose a great deal more than English prices in the sixteenth century, and the Spanish peak came forty years earlier (see Hamilton 1934).
While prices in England were rising 150 per cent in the sixteenth century, wages were apparently rising only 30 per cent. While prices in France were rising 150 per cent from the first to the last quarter of the sixteenth century, wages were rising only 25 per cent. In 1676–1700 French prices were twice as high as in 1521–1525, and wages were only a third higher. During the seventeenth century the price-wage ratio had become slightly less beneficial to employers and less harmful to workers, but the change was probably too small for any worker or employer to notice during his lifetime. By the end of the seventeenth century English wages were 150 per cent higher than in 1501–1510, while prices were 250 per cent higher. The gap between prices and wages remained wide, although it was far smaller than in 1600. Apparently wages in Alsace lagged farther behind prices during the Price Revolution than in England but less than in France. Wage indexes for Lvov, Poland, on a 1521–1525 base stood lower than price indexes in every decade from 1525 to 1700, but the gap seems to have been great only in 1551–1560 and in 1651–1700. Charts of raw data presented by Elsas (1936–1949) indicate that wages of two grades of labor lagged behind prices of rye at Augsburg, Munich, and Wiirzburg from about 1540 to 1630.
The chief cause of the Price Revolution of the sixteenth and seventeenth centuries was the great increase in the money supply. Higher output of silver in Europe, particularly in Germany, beginning in the last quarter of the fifteenth century, arrested the downward trend of prices and, along with imports of gold from the Antilles, caused prices to turn upward early in the sixteenth century. But it was the explosive rise in silver production after the conquests of Mexico and Peru; the discovery of the fabulous mines of Zacatecas, Guanajuato, and Potosi; and the introduction of the mercury amalgamation process of mining in the middle of the sixteenth century that generated the Price Revolution. The sharp rise in prices began earlier and was more violent in Andalusia, where all the bullion legally imported into Europe from the Spanish colonies landed, than in any other area in Europe for which we have satisfactory data. It was in New Castile, the region closest to Andalusia, that the Price Revolution began next and was second in magnitude. In fact, it was higher prices in Spain than elsewhere and, to a much lesser extent, royal expenditures for war, diplomacy, and the administration of the European empire, that distributed the precious metals among other countries. Of course, some bullion leaked into other kingdoms directly from the New World. The lag of French and English prices behind Spanish prices and the similar ultimate rise in each country indicates that specie from the New World was the leading factor in the price upheaval in all three countries (see Hamilton 1934).
We know approximately how much specie came into Europe legally from the Hispanic colonies in 1503–1660, while the Price Revolution was in progress; but we do not know how much was smuggled into Spain and other kingdoms or what the total money supply was in about 1500. But there are strong reasons to believe that the increase in the money supply during the Price Revolution was much greater percentagewise than the rise in prices. Rather than seeking ancillary causes of the Price Revolution, as most writers (beginning with Jean Bodin and including the present one) have done, one needs to explain the failure of prices to keep pace with the increasing stock of precious metals. Some of the new bullion was neutralized by the increased use of gold and silver for nonmonetary purposes as they became relatively cheaper through rising commodity prices. After the discovery of the Cape route to the East, the age-old flow of bullion from the West to the East was intensified. Once in the East, much of the bullion was hoarded or used ornamentally, so that the continuous inflow of specie did not raise Eastern prices enough to reverse the flow. But these outlets did not prevent unprecedented additions to the European monetary stock. A major counterpoise to the rise in the money supply was the increased flow of goods onto markets, resulting from great technological advances and a large increase in population. Conversion of produce rents into money payments, a shift from wages partially in kind to money wages, and a decline in barter also tended to counteract the effect on prices of the increase in gold and silver money. And with real national incomes and wealth increasing, the velocity of circulation of money presumably declined.
During the first third of the eighteenth century, the trend of prices in most countries was moderately downward, and wages moved horizontally. A marked increase in the output of silver in Mexico and (though much less significant) of gold in Brazil arrested the secular decline of prices about 1735. These factors, with assistance from wars and from deposit and note creations by banks, forced prices upward about 35 per cent in London—according to indexes I have computed from data in Beveridge (1939)—and 65 per cent in New Castile and Holland in 1750–1790. In all three areas prices approximately doubled from 1735 to 1800 under the same forces, and prices in Philadelphia rose about 125 per cent. While prices were rising 35 per cent in London, the wages of artisans and unskilled laborers in the building trades, which seem to have been representative for most grades of labor, advanced only 15 per cent, according to wage indexes I have computed from series in Gilboy (1934), since Beveridge supplies no wage data. While prices were doubling, wages rose only 20 per cent. The price series compiled by Labrousse for France (1933) shows a rise of 64 per cent from 1726–1741 to 1784–1789, and his wage series shows a rise of only 22 per cent. Although prices in New Castile rose somewhat more in 1750–1790 than in France from 1726–1741 to 1784–1789, wages rose a little less.
The strategic role of changes in the supply of silver money in Spanish price movements is demonstrated by the falling prices during the war with France and England in 1719–1720 as well as during the War of the Austrian Succession and by stable prices during the 13 months Spain was in the Seven Years’ War. During these wars specie flowed out and British sea power obstructed imports from the New World. When the suspension of hostilities permitted bullion impounded during these conflicts to flow into Spain, prices rose. Since paper money filled the void in 1779–1783, prices increased; but they rose more in the first two years of peace, when specie pent up in America arrived, than in four years of war and paper-money inflation (see Hamilton 1947).
The end of the 18th century brought two hyperinflations caused by the overissue of paper currency. Under the assignats and mandats in the 1790s France had the only hyperinflation she has ever experienced. In Philadelphia prices rose two hundredfold from the outbreak of the Revolution in 1776 to the battle of Yorktown in 1781, and “not worth a Continental” still reminds Americans of their Revolutionary currency.
Nineteenth- and twentieth-century price movements. That prices were remarkably stable in England and the United States in the nineteenth century is a myth accepted by many great economists. They were, as compared with the twentieth century, but not as compared with the five centuries that had gone before. Prices in Philadelphia rose nearly 50 per cent from 1801 to 1814, and from then until 1847–1850 they fell nearly 60 per cent. From 1816, when data begin, to 1847–1850 prices in Cincinnati dropped 58 per cent. From 1818 to 1847–1850 prices in England fell 50 per cent in money of account and nearly as much in gold. During this period money wages declined very little in England and rose slightly in the United States. The chief factors in the severe downward trend of prices were (1) postwar readjustment on an unprecedented scale, including the return to a metallic standard at prewar parity, (2) a decline by half in the output of precious metals in Latin America because of the wars for independence and political instability under the new governments, and (3) a great increase in the production of goods resulting from improved technology, revolutionary changes in transportation, soaring population, and the exploitation of vast new areas with rich natural resources.
Serious short-term price declines also occurred. From the fourth quarter of 1836 to the fourth quarter of 1842 British prices fell about 22 per cent. From January 1817 to January 1822 prices fell 24 per cent in Philadelphia and nearly 60 per cent in Cincinnati, where raw materials were a much larger component of the index numbers. From the first quarter of 1837 to the first quarter of 1843 prices dropped 25 per cent in Philadelphia and 58 per cent in Cincinnati.
From 1847–1850 to 1873 prices rose nearly 40 per cent in England, France, and Germany, and nearly 60 per cent in the United States. The American Civil War, with its paper money aftermath, and the Franco-Prussian War both exerted upward pressure on price levels. But the chief cause of the upheaval was the great increase in gold production following the discovery of rich gold fields in California in 1848 and in Australia in 1851. Since a proposed shift from the gold standard was hotly debated in England in the 1850s, and actually occurred in Holland in 1851, to combat expected gold inflation, presumably an increased velocity of circulation intensified the effect of a rising money supply.
History came as near to repeating itself in 1873–1896, by duplicating the price movements of 1815–1850, as it ever does. Prices in gold fell 41 per cent in France, 42 per cent in England, and 43 per cent (49 per cent in money of account) in the United States. The annual rate of decline was even greater than in the earlier period, and the causes were strikingly similar. The decline was due largely to (1) widespread demonetization of silver in the 1870s, (2) a falling cumulative rate of growth in the gold stock, (3) exploding population, and (4) increased production of goods resulting from remarkable advances in technology and transportation and from the utilization of important new natural resources.
Alaskan and South African gold discoveries and chemical improvements in the process of extracting gold from ore reversed the steep downward trend of prices. From 1897 to 1914 they rose about one-third in England; four-tenths in France and Germany; and one-half in Canada, Russia, and the United States. World War i sharply accelerated the upswing. Never before in modern times had there been such war expenditures, fiscal deficits, and monetary inflation or such disruption of trade, mobilization, and reduction in the supply of civilian goods. And never before had there been such a violent and universal rise of prices in both belligerent and neutral countries. An acute shortage of goods, the urgent need to reconstruct devastated areas, and low market rates of interest extended the advance of prices in most countries for about two years after the armistice. From the outbreak of war to their peak, prices advanced about 120 per cent in Spain, 130 per cent in the United States (as in the Civil War of 1861–1865), 145 per cent in Canada, 160 per cent in Japan, 205 per cent in Great Britain, 275 per cent in the Netherlands, and 410 per cent in France.
Almost everywhere prices collapsed in late 1920 and early 1921, but they were unusually stable in most places in 1922–1929. Hyperinflation in Germany reduced the value of the mark to zero from 1919 to 1923, but prices moved horizontally from the currency reform in 1924 to 1929.
From the last quarter of 1929 to 1932 there occurred one of the most severe and widespread falls in commodity prices in history. Apparently no country was spared. India and the Netherlands, with decreases of 36 per cent and 46 per cent respectively, were among those suffering the greatest declines. In France, Italy, Great Britain, the United States, and Canada prices fell from 28 to 32 per cent. As in all cyclical downswings, prices of agricultural products and other raw materials fell much farther than prices of finished consumer goods. Countries and sections of countries that predominantly produced raw materials were critically injured. Laborers suffered massive unemployment. Although the trend of prices was upward after 1933, unemployment and agricultural distress lasted until the outbreak of World War II.
Since much of the literature in money and banking and labor statistics is concerned with the price level and the cost of living in the last 25 years, price history may logically end with the eve of World War II
Earl J. Hamilton
[See alsoAgriculture, article onHistory; Index numbers, article onPractical applications.]
BIBLIOGRAPHY
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Bezanson, Anne; Gray, Robert D.; and Hussey, Miriam1935 Prices in Colonial Pennsylvania. Philadelphia: Univ. of Pennsylvania Press.
Bezanson, Anne; Gray, Robert D.; and Hussey, Miriam
1936–1937 Wholesale Prices in Philadelphia, 1784–1861. Parts 1–2. Philadelphia: Univ. of Pennsylvania Press.
Bodin, Jean (1568) 1932 La vie chére au Xvie siecle: La response de Jean Bodin a M. de Malestroit. Edited by Henri Hauser. Paris: Colin. → A new edition of Response aux paradoxes de M. de Malestroit.
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Prices
Prices
Prices are the rates at which goods and services are exchanged for other goods and services, or for money. In a monetized economy, the term price usually connotes the amount of money for which a good or service is purchased or sold. While in conventional usage, the term price is applied only to goods and services, in economic analysis, wages, interest rates, rents, and other money exchange rates for specialized services are also considered prices.
Prices have a critical coordinating role in a market economy. Ordinarily, an increase in a good’s price conveys the information that it has become scarcer relative to the demand for it, either because its supply has fallen or because the demand for it has risen. A higher price induces existing producers to supply more of the good, and it attracts new entrants into an industry, since it tends to be associated with a higher-than-normal profit margin. Conversely, a declining price leads to reduced supply. Economists see these reactions as being exactly what is required for social efficiency, since resources should be withdrawn from uses that are less valued and drawn into uses that people value more.
Economist and social theorist Friedrich Hayek (1899–1992) argued that prices convey information about “global” (or society-wide) conditions to “local” actors (such as business owners), thereby solving a core informational problem faced by a society when it attempts to decide how best to allocate scarce resources. Hayek argued that the compactness or one-dimensionality of prices and the fact that they arise spontaneously as byproducts of self-interested buying and selling activities makes them a uniquely economical way to coordinate society’s resource allocation process. In the “socialist calculation debate” of the 1940s, Hayek argued that it is impossible to solve the problem of efficiently allocating resources among productive activities in an economy of specialized producers without market-generated prices. During the middle decades of the twentieth century, the apparent economic viability of the Soviet Union and like economies was sometimes viewed as contradicting that claim; yet reform-minded economists in the socialist world asserted the validity of Hayek’s argument when political conditions allowed the matter to be discussed and their views ultimately prevailed.
Economic analysis distinguishes between nominal and real prices. The real price of a good is its price relative to the prices of other goods, while its nominal price is its price denominated in a currency the value of which may be changing over time. For example, if all nominal prices, including wages, were to double over a certain span of time, the real price of any given good would remain unchanged. The terminology reflects the idea that money is merely a medium of exchange without an intrinsic value of its own, and that what matters economically is therefore relative prices, including the purchasing power of people’s money incomes.
In practice, changes in a country’s price level can have real consequences. Inflations rarely affect all prices in perfect proportion. For this reason, and because of their asymmetric effect on, for instance, debtors versus creditors, they have significant distributional consequences. In a world of many countries and currencies, differences in rates of change in price levels affect international trade and payments. Unpredictable price changes increase risk, discouraging some investing and trading activities. Rapid price change can give rise to real costs, such as those associated with having to recalculate and reprice items frequently, the pressure to spend money as soon as it is earned, and the need to print and to carry large quantities of money.
Classical economists such as Adam Smith (1723–1790) distinguished between natural prices and market prices. While the terminology suggests that the “natural price” may have an underlying ethical quality, modern historians of economic thought generally understand the term to have been a reference to what would today be called a “long-run equilibrium price,” that is, the price at which a normal or average rate of profit can be earned. This is the level toward which a good’s price will adjust in the long run, through expansion or contraction of output by current producers and through exit of old and entry of new producers into the market. The “market price” is simply the price at which a good is sold at any given point in time. Since changes in supply or demand are always occurring, market prices are the prices we actually observe, while natural or long-run equilibrium prices are idealized or theoretical indicators of long-run tendencies.
Neoclassical economic theory teaches that allowing prices to be governed by the forces of supply and demand is the best way to permit them to play their role of signaling scarcity and guiding the ongoing reallocation of resources to their most valued ends. When governments intervene by setting price floors or ceilings, by taxing the sale of some goods but not others, by imposing tariffs on imports, by subsidizing some producers, or by directly determining what prices can be charged, prices become “distorted” and can no longer be counted upon to steer resource allocation toward efficient uses. In an economy in which prices are significantly distorted or controlled in these ways, it remains possible in principle to calculate what prices “should” be, that is, what they would be if market forces were permitted to determine prices freely and exclusively. The true “scarcity-reflecting” prices thus calculated are referred to by economic theorists as shadow prices, and they play important roles both in theoretical analysis and in some practical policy exercises.
On closer inspection, however, unregulated prices are not always the ideal, even according to neoclassical economic theory. Monopolists can push prices above levels associated with normal profit rates and efficient supply. The market prices of goods whose production destroys unpriced resources, such as clean air and water, systematically understate their true cost to society. Government interventions, such as setting a maximum price for a monopolist, breaking up monopolies so that competition will bring down prices and increase supply, or taxing polluters to force them to internalize costs they might otherwise impose on society, can at least in principle improve upon unregulated outcomes, although knowing how a government will act in practice requires an understanding of a range of political and economic factors.
Scholars who compare economic systems of different types emphasize that prices play more than a scarcity-signaling role in an economy. Prices also determine the relative incomes of different groups of economic actors. For example, higher real wages may mean lower profits and hence a smaller income gap between wage versus profit earners. A higher ratio between the wages of more-educated or skilled and less-educated or skilled workers was associated with rising income inequality in industrialized economies during the last decades of the twentieth century. In the heyday of the Soviet Union and other planned economies, planners set the wages of urban workers and the prices paid to farmers for their produce at levels consistent with the proportions of consumption versus investment desired by the political authorities. In this way, they used control over wages and prices as a method of dictating high rates of capital formation. Prices also functioned as accounting aids in the centrally planned economies. Their existence allowed economic planners to monitor the fulfillment of plan targets through a system of indicators (money flows) parallel to but distinct from indicators of physical input and output.
Their impact on the distribution of wealth, for instance between sellers and buyers, also explains why prices attract ethical attention, as epitomized by medieval European discussions of the “just price.” Sellers of a resource in plentiful supply, for example unskilled labor, cannot command high prices (wages) for their service under competitive conditions, resulting in their poverty in comparison with those selling a scarce resource—perhaps access to fertile land. Companies in the oil industry earning large profits in the wake of short-run supply shortfalls attract ethical and political attention because a higher price for transportation and heating fuel means poorer consumers and wealthier company owners. Governments sometimes try to prevent such transfers by fixing a maximum price. If the supply of the commodity in question is fixed, the price ceiling will cause demand to outstrip the available supply, which will then be “rationed” by some nonprice mechanism—perhaps willingness or ability to wait in line, perhaps rules governing who can purchase on which day of the week, or perhaps government issue of coupons in limited number. In some circumstances, rationing a scarce but crucial commodity may be preferable to letting market forces operate, but in eliminating the short-run windfall that would otherwise accrue to suppliers, it can also slow the expansion of output that would reduce the commodity’s scarcity in the long run.
Many governments set minimum wages, tax high incomes at steeper rates than low ones, or engage in other price-altering interventions in order to protect disadvantaged groups or moderate income inequalities. But governments face pressures from constituencies other than the poor, which also leads to price interventions. For example, tariffs preserve the profits of domestic producers at the expense of domestic consumers, and often also at the expense of forces promoting long-run competitiveness. The effect of prices on the distribution of income helps to explain a variety of government price-altering policies.
SEE ALSO Aggregate Demand and Supply Price; Interest, Natural Rate of; Long Period Analysis; Long Run; Rent; Shadow Prices; Short Period; Short Run; Spot Market; Wages
BIBLIOGRAPHY
Hayek, Friedrich. 1945. The Use of Knowledge in Society. American Economic Review 35: 519–530.
Kohler, Heinz. 1996. Economic Systems and Human Welfare: A Global Survey. Cincinnati, OH: South-Western College Publishing.
Mas-Colell, Andreu, Michael Whinston, and Jerry Green. 1995. Microeconomic Theory. New York: Oxford University Press.
Montias, John Michael, Avner Ben-Ner, and Egon Neuberger. 1994. Comparative Economics. Chur, Switzerland: Harwood Academic.
Varian, Hal. 1992. Microeconomic Analysis, 3rd ed. New York: Norton.
Louis Putterman
Prices
PRICES
PRICES. By "price" economists mean the rate of exchange of one good, typically money, for another. Prices convey information to producers, consumers, and government essential to efficient decision making. By attaching values to goods and factors of production, prices affect the allocation of resources and thereby shape the distributions of consumption and income across individuals and nations.
Setting and Measuring Prices
Some prices are set by custom, by bargains struck between individual buyers and sellers, by businesses with "market power" (such as monopolies), or by government fiat. However, in a large, capitalist economy like that of the contemporary United States, most prices are determined by the interchange of numberless and typically anonymous buyers (demand) and sellers (supply) in competitive markets.
To measure the overall level of prices, economists construct price "indexes," essentially weighted averages of prices of specific goods. The index is set equal to unity (or 100) in a base year, and prices in any other year are expressed relative to prices in the base year. An index of "producer prices" refers to prices received by supplies commodities. The "consumer price index" measures prices paid for goods and services purchased by consumers. In the case of the consumer price index, the weights refer to the relative importance of the goods in consumer budgets. Ideally, the introduction of new products, improvements in the quality of existing goods, and changes in the weights should be reflected in the construction of the indices. In practice, this may be difficult or impossible to do, particularly with historical data.
Over the course of American history, both the price level and the structure of relative prices have changed markedly. Most economists believe that sustained changes in the level of prices are caused primarily by sustained changes in the supply of money per unit of output, although other factors may be relevant in specific historical periods.
From the point of view of consumers, the single most important change in relative prices has been a substantial long-term rise in the "real wage": the money wage relative to the price level. Most economists believe that, in the long run, increases in real wages reflect increases in labor productivity. Other examples of changing relative prices include new products and regional differences. Typically, new products are introduced at high relative prices that moderate over time as the products are improved. A spectacular example is the computer: on average, computer processor prices declined by 20 percent per year from the early 1950s to the mid-1980s. Historically, there were significant regional variations in relative prices in the United States, but these differences have diminished as internal (and international) transport costs have fallen, and national (and global) markets have evolved.
Price Trends in American History
Economic historians and economists have charted the course of prices in the United States from the earliest settlements of the seventeenth century to the present day. Fragmentary information suggests that prices were falling throughout the seventeenth century as the demand for money (shillings) grew faster than the irregular supply. Variations in relative prices across colonies were common, as were localized, and of ten sudden, inflation and deflation. As trade expanded and as the money supply became more regular, prices began to rise and price fluctuations to moderate. The development of wholesale commodity markets in the major port cities—Boston, New York, Philadelphia, and Charleston—led to the regular publication of price information in broadsheets or in tabular form in local newspapers known as "Prices Current," and these have facilitated the construction of historical price indexes beginning in the early eighteenth century.
The revolutionary war witnessed one of the first (if not the first, the French and Indian War being a precursor) occurrences of wartime inflation in American history. Prices fell after the mid-1780s but soon rose again sharply beginning in the mid-1790s through the War of 1812. Prices fell sharply from their wartime peak in 1814, and continued to fall until reversing course in the early 1830s. The fall in prices that occurred after the panic of 1837 cemented in place a cyclical pattern in prices that, while hardly new to the economy, would be repeated several times up to and including the Great Depression of the 1930s—prices generally rose smartly during booms, but then fell, sometimes quite abruptly, during a recession.
Following the recession of the early 1840s, the last two decades of the pre–Civil War period were generally a period of rising prices. Beginning in 1843, prices rose more or less continuously until once again declining in the wake of the panic of 1857, but stabilized shortly thereafter. Despite the increases of the preceding twenty years, on the eve of the Civil War the overall level of prices was still well below that experienced in the late eighteenth and early nineteenth centuries.
The war years (1861–1865) witnessed substantial—uncontrollable, in the South—increases in prices due to the issuance of paper money by both the Union and Confederate governments. Prices rose sharply, and more importantly, relative to wages, created an "inflation tax" that helped both sides pay for the war effort.
Prices fell after the Civil War, and except for a minor upswing in the early 1880s, continued on a downward trend until the late 1890s, when an expansion in the worldwide supply of gold produced an increase in the money supply and a rising price level that stabilized just before the outbreak of World War I. As during the Civil War, prices rose rapidly during World War I, as the sale of war bonds fostered an expansion of the money supply in excess of the growth of production.
Prices fell sharply after the end of World War I and remained stable for the remainder of the 1920s. Stock prices were an important exception. Fueled by the postwar boom, these prices rose to unprecedented heights, before crashing down in October 1929. The depression that followed was by the far the worst in American history. Just as it had in previous downturns, the price level fell sharply between 1929 and 1933. Money wages also fell, but not as much as prices. Real output per capita decreased, and unemployment soared to nearly a quarter of the labor force in 1933. Prices began to recover after bottoming out in 1932, but fell again when the economy again went into decline late in the decade. In 1940, on the eve of U.S. entry into World War II, the price level was lower than it had been in 1930, and lower still than in the 1920s.
With the entry into the war, the nascent economic recovery accelerated, and unemployment, which had stood at nearly 15 percent in 1940, declined sharply. The war effort put severe upward pressure on prices that, officially at least, was checked through the imposition of wage and price controls in 1942. Unofficially, price rises exceed those recorded by the government: black market activity was rampant, and black market prices do not figure into the official price indexes of the period. After controls were lifted in 1946, the price level rose rapidly, reaching a level in 1950 slightly more than double the level in 1940.
Since 1950, the American economy has experienced a steady and substantial rise in price level, although the rate of increase—the inflation rate—varied across decades. Consumer prices rose by 23 percent in the 1950s and by another 31 percent in the 1960s. These increases were sufficient to prompt the Republican administration of President Richard Nixon to impose wage and price controls from 1971 to 1974. In the end, however, the controls did little to stem rising prices, particularly after an international oil embargo in 1973–1974 caused a sharp spike in energy prices. By the end of the decade, the price level had risen a stunning 112 percent over the level prevailing in 1970. The price level continued to rise in the 1980s and 1990s but at a much reduced pace. By the end of the 1990s, the cumulative effects of post-1950 increases in the price level were such that one 1999 dollar purchased the equivalent of $0.19 in 1950 prices.
Information on prices is routinely collected by government agencies and by the private sector. At the federal level, much of the responsibility is entrusted to the Bureau of Labor Statistics and the Bureau of Economic Analysis. Indexes produced by these agencies are published regularly in government documents such as Statistical Abstract of the United States and on-line at agency Web sites. For historical price indexes, readers are directed to the various editions of Historical Statistics of the United States.
BIBLIOGRAPHY
Cole, Arthur H. Wholesale Commodity Prices in the United States, 1700–1861. Cambridge, Mass.: Harvard University Press, 1938.
Gordon, Robert J. The Measurement of Durable Goods Prices. Chicago: University of Chicago Press, 1990.
Hanes, Chris. "Prices and Price Indices." In Historical Statistics of the United States: Millennial Edition. Edited by Susan B. Carter, Scott S. Gartner, Michael Haines, Alan L. Olmstead, Richard Sutch, and Gavin Wright. New York: Cambridge University Press, 2002.
McCusker, John J. How Much Is That in Real Money? A Historical Price Index for Use as a Deflator of Money Values in the Economy of the United States. 2d ed. Worcester, Mass.: American Antiquarian Society, 2001.
U.S. Bureau of the Census. Statistical Abstract of the United States: The National Data Book. 120th ed. Washington, D.C.: Government Printing Office, 2000.
———. Historical Statistics of the United States: Colonial Times to 1970. Washington, D.C.: Government Printing Office, 1976.
Robert A.Margo
See alsoBusiness Cycles ; Consumer Purchasing Power ; Cost of Living ; Inflation ; Price and Wage Controls .
prices
Prices for individual commodities vary as market conditions of supply and demand fluctuate. If demand rises then, without a commensurate increase in supply, prices will also rise. Equally, a contraction in supply will, other things unchanged, result in higher prices. In the past, for instance, the price of foodstuffs fluctuated considerably according to the nature of the harvest—poor harvests in the 1840s, for example, pushing up the price of wheat and potatoes. Speculation about future market conditions can also result in price changes with anticipation of shortages pushing up prices. There may also be price rises if the currency is debased (e.g. the gold content of coins reduced) or confidence is lost in its acceptability.
A general rise in prices across all commodities is inflation and a fall in prices is deflation. The rate of inflation in Britain has fluctuated considerably although never to the same extent as experienced in countries such as Germany, which suffered hyperinflation in the late 1920s. Britain was affected by the severe inflation experienced across the Roman empire under Diocletian in the 3rd cent. but price data do not exist for England until the Middle Ages. The medieval period saw only modest overall general price rises although there were periods of rising prices—e.g. after the Black Death had swept Europe (1348/9)—interspersed with periods of falling prices. This trend continued through the next centuries but with bouts of rapid price rises. These periods of high inflation were often associated with wars and the pressures to finance them. Wars increase the demand for goods but reduce the available resources to produce them. Prices rose, for instance during the Revolutionary and Napoleonic wars (1793–1815). There have also been times, most notably in the Tudor period, when the currency has been debased, reducing its value and creating general price rises. Since the deflation of the Great Depression of the 1930s, however, Britain, in line with other industrial countries, has experienced consistently gradually rising prices. The price increases have generally been low, 2–4 per cent a year, but have included a period of quite rapid inflation—over 10 per cent p.a.—in the early 1980s.
The underlying causes of general price rises are disputed but, since high levels of inflation are seen as socially inequitable and can reduce confidence in a country's economy, understanding them is important for policy-making. Traditionally, classical economists supported the quantity theory of money as explaining price levels. The idea, in its simple form, was that any increase in money supply directly pushes up prices. To contain inflation, advocates of this school look to controlling the money supply. The more recent Keynesian theories focus on aggregate demand and market distortions—demand pull theories of inflation. They emphasize the role of price controls and the regulation of total expenditure.
The state has periodically attempted directly to regulate prices. There is a long history of price controls over monopoly suppliers. When markets are perfectly competitive, no individual actor has sufficient influence to affect prices—they are determined by Adam Smith's ‘invisible hand’. Where markets are imperfect, those with monopoly (or monopsony) power can withhold supply and increase prices beyond the competitive level. Action is then taken either to limit prices by reducing the monopoly power of the supplier or by acting directly on the prices permitted.
At various times in recent history there have also been efforts by government to control the general prices (e.g. price and incomes policies) especially during wartime and as a counter-inflation strategy. In some instances (e.g. for periods of rationing during the world wars) the price mechanism has been abandoned over parts of the economy. Macro-efforts at price control have, however, in general, proved to be singularly unsuccessful as long-term policies, producing political difficulties and tending to run against the natural tide of market forces.
Kenneth Button