Free market vs. price controls: as gas prices hit record highs, calls are inevitable for government to remedy the "problem" through price controls--though that solution hasn't worked in the past.(OIL)(Cover story)

It wasn't hard this semester to get my freshmen students in Principles of Macro-economics interested in supply and demand. With headlines warning that gas could hit $5 per gallon, they had no shortage of questions, and answers.

"That'll be $100 for a fill-up," said one student, adding, "Why doesn't the government just put a lid on prices?" Suggested another: "They're going to have to increase the minimum wage, so people can afford to get to work."

My explanation about how things can't be fixed that easily, explaining why a government-imposed price "ceiling" in the case of gas and mandated price "floors" in the case of minimum wages will most likely only have the unintended consequence of producing more gas shortages and more unemployment, provided this freshman class with their initial lesson in why economics is called "the dismal science."

Supply and Demand

Here's how Milton Friedman explains the problem with price controls in Free to Choose: "Economists may not know much. But we know one thing very well: how to produce surpluses and shortages. Do you want a surplus? Have the government legislate a minimum price that is above the price that would otherwise prevail."

An example is the government's minimum prices for farm products, which have the effect of producing massive surpluses of butter, wheat, etc. It's the same in the labor market. Raise the minimum wage to $10 so people can afford higher gas prices, and the result will be a government-induced production of a surplus--a surplus of workers, i.e., higher unemployment.

That jump in unemployment, directly hitting the intended beneficiaries of the government intervention, inevitably happens because a hike in the mandated minimum wage has the direct effect of attracting more people into the labor market at exactly the same time that employers are seeking to cut their newly inflated payrolls. The result is more supply and less demand, either of which produces a surplus. Generate both of these supply and demand changes simultaneously, and it's a double blow to employment.