Why the government has no business controlling prices of essential goods

One of the most important issues to Americans is how to manage prescription drug prices, especially for seniors who depend on medicare coverage.

Some policy advocates are urging the federal government to contract directly with drug manufacturers to purchase drugs for seniors — at prices set by the government.

Despite the high-minded intentions of these advocates, such price controls could be harmful to Americans’ future health.

When prices are held below natural levels, resources such as talent and investor capital leave an industry to seek a better return elsewhere.

This means that there will be less discovery and innovation, and fewer new drugs will become available to consumers.

Often this change happens over the long term — longer than the tenure of any policy-maker.

Thus, it is vitally important to remind policy-makers of the effects of price controls whenever they are proposed as government policy.

The determining of market prices through the dynamic interaction of supply and demand is the basic building block of economics.

Consumer preferences for a product determine how much of it they will buy at any given price.

Consumers will purchase more of a product as its price declines, all else being equal.

Firms, in turn, decide how much they are willing to supply at different prices.

In general, if consumers appear willing to pay higher prices for a product, then more manufacturers will try to produce the product, will increase their production capacity, and will conduct research to improve the product.

Thus, higher expected prices lead to an increased supply of goods.

This dynamic interaction produces an equilibrium market price; when buyers and sellers transact freely, the price that results causes the quantity demanded by consumers to exactly equal the supply produced by sellers.

But when government adopts a price control, it defines the market price of a product and forces all, or a large percentage, of transactions to take place at that price instead of the equilibrium price set through the interaction between supply and demand.