Price Controls in International Trade: Definition & Examples

Instructor: Martin Gibbs

Martin has 16 years experience in Human Resources Information Systems and has a PhD in Information Technology Management. He is an adjunct professor of computer science and computer programming.

Price controls may be implemented to benefit a certain group, but they have consequences. This lesson will discuss price controls and their impact on trade.

Price Controls

Economists typically don't care for controls on price: In a perfect world, the market would take care of itself. However, in the real world, governments can and do set price limits for certain goods.

A price control is a set price limit, either maximum or minimum, for a given good. The minimum price is also called a 'floor'; the maximum a 'ceiling'. Price ceilings lead to shortages, because producers may not be able to supply as much product at the set price. Price floors, on the other hand, can trigger a surplus since the price is lower. This might lead to a government-imposed restriction on production. These consequences are a result of interference with market forces.

The following graphic shows how price ceilings create the shortage: The market price is noted by the red circle, but the blue ceiling line is below this... thus there is a shortage.

Shortage Resulting From A Price Ceiling
price controls ceiling

Now look at the price floor: A similar graphic, but now there's a surplus, since the floor is above the market price.

Surplus Resulting From A Price Floor
price controls floor

On their surface, controls look like good ways to help consumers (or suppliers, given the control); but controlling the price of a good is interference with natural economic forces. This manipulation has consequences, especially when it comes to international trade.

Examples

Let's take a look at some real-world examples. Controls on the steel industry had long-lasting effects, and current controls on pharmaceuticals are an issue today. We'll also look at how local/domestic policies impact international trade.

Steel

Price controls can have long-term and far-reaching consequences. In the 1960s, price controls were placed on U.S. steel, even though other costs in the industry kept going up. Steel was a highly-used commodity at that time in the US, and there were fears that price increases would negatively impact other sectors of the entire economy. As a result, steel companies cut costs in other areas, including technology and upgrades to plants. While this worked in the short term, the stagnation resulted in new opportunities for other steel manufacturers.

Japan rose as a steel supplier, which also resulted in U.S. steel losing massive chunks of market share. By manipulating the price and interfering with market forces, the consequence was negative (even though the intent was to avoid a negative impact!) We can only speculate as to the outcome had prices been left alone.

Pharmaceutical Products

Currently, there are numerous industrialized nations that have price controls on pharmaceuticals. This has a negative impact on trade: studies show that drug makers don't want to work on new treatments if governments are going to set limits on the price of a new drug. Yes, drugs are expensive, but a lot of money goes into research and development; if a company can't recoup those costs in sales, they may stop producing certain treatments and therapies.

The other consequence is that a type of black market forms: Consumers seek out cheaper pharmaceuticals across the border, or overseas. Assume that another country has price controls on pharmaceuticals to lower the cost to consumers and American citizens are now seeking out those drugs. Since the drugs have left United States jurisdiction and regulatory oversight, the consumer isn't guaranteed the the drug is safe. It could be the wrong dose, or even the wrong type! One of the underlying contributors to this situation is the price control.

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