Sep 29 2009

China’s “visible hand” clamps down on rising prices

This article was originally posted on September 19, 2007

FT.com / Asia-Pacific / China – China freezes government-set prices

Here’s a great article for both AP and IB students to pay attention to. The Chinese government is responding to rising prices at home by resorting to some good old fashioned “iron fist” measures, namely price controls on a wide range of products. For the rest of this year, prices on certain goods and services will not be permitted to rise, OR ELSE! (what? we don’t want to know!)

China has begun to enforce a freeze on all government-controlled prices in a sign of the central government’s alarm about rising popular anger over inflation, now at the highest rate in over a decade.The order freezes a vast array of prices still under the control of governments in China, ranging from oil, electricity and water, to the cost of parking and park entrance fees.

I find the following statement interesting:

“Any unauthorised price rises are strictly forbidden…and in principle, there will be no new price-raising measures this year,” the ministries’ announcement said. (italics added)

How strange is it that the government’s announcement pointed out that the freeze on prices is only in principle? Could this be the government’s attempt to placate a public that’s grown angry at their weakening purchasing power? Does this mean that if prices actually do go up, the government can just say, “Hey, at least we tried!” Looks like the old communist mentality has softened a bit in the era of market reforms!

So what’s the source of all these rising prices? Well, food plays a big role, thanks to a couple of factors:

The sharp spike in inflation is largely due to higher food prices, because of a shortage of pigs after a disease killed millions late last year and earlier in 2007, and the rising cost of feed, a global
phenomenon.

The China of today is very different from that of 20 or 30 years ago, when the government played a much larger role in the economy. Unleashing the beast of the free market in the early 80’s may have meant the government would have to loosen its grip in situations such as today’s inflation, and let the free market adjust on its own.

Economists said the price freeze is the kind of administrative measure redolent of China’s former planned economy, but it may be less effective in China today.

“They will not be able to control the price of everything,” said Chen Xingdong, of BNP Parisbas in Beijing.

Perhaps that’s for the better.

Discussion Questions:

  1. Why might the government’s price controls actually make the matter worse for the average Chinese?
  2. If the government were to take a “laissez faire” approach to the problems faced by China, how might the free market resolve them on its own? Any ideas?

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

18 responses so far

18 Responses to “China’s “visible hand” clamps down on rising prices”

  1. Angel Liuon 21 Sep 2007 at 8:56 pm

    A price ceiling can temporarily ease inflation, but in the long run, there are less goods available as suppliers decrease quantity in production, and as supply decreases and demand remains, shortage deteriorate. Since demand is unchangeable because of people's needs for foods and gas, an increase in supply can decrease price, thus satisfying consumers' demands. A free market will adjust by itself to reach the equilibrium: firms will improve its efficiency, consumers will switch between substitutes for the lowest price. China's inflation will not improve under the government's so called principle

  2. andyxuon 23 Sep 2007 at 1:15 pm

    The price-freeze on pork and other food products is unwise because the government does not realize underlying causes of this recent price boom.

    One is the inflation of the yuan, causing pig farmers to pay more for supplies needed to raise pigs, thus increasing production costs.

    The second is the strain that the government places on all farmers in China – the lack of subsidies and property rights. Because farmers cannot obtain private land to farm, their revenues from agricultural products cannot keep up with inflation. Their much needed financial aid is not supplied, and so their only way to "survive" is to increase the price of their products.

    To the average consumer, the government appears to be helping them by enabling more purchases of food. However, what the government is doign is straining producers' scare revenues, reducing their outputs because they are forced to migrate elsewhere where it is possible to earn a living. To the rest of the farmers, problems such as the quality of meat, substituting required processing ingredients with unsafe chemicals to lessen costs, will arise. This further reduces the supply of food. Therefore, the price-freeze will not benefit the producers nor the consumers.

    Regarding to the price-freeze in parking and park entrance fees, the tactic might prove useful, assuming that the government enforces this law. It is common in China that state-firms acquire land at valuable locations for free (especially decades ago), then charge heavily for parking or park entrance fees. The money received often goes to a few corrupted men from these state-firms. They endure no costs (because land is free) and still creates a huge (unfair) revenue.

    Perhaps it is for the interest of citizens that the central government sets up this price-freeze. It should also be noted that the inability of the government to enforce its vague policies is too common.

  3. Howard Jingon 25 Sep 2007 at 2:31 pm

    In a "laissez-faire" approach, I think that China would eventually begin importing more and more pork from other countries, or rely on cheaper substitutes such as fish, pork, or beef. Maybe China will eventually come to think of pork as a luxury instead of a necessity and dramatically reduce demand for it until there is enough Chinese pork for everyone.

  4. kevinchiuon 26 Sep 2007 at 10:02 am

    The average Chinese person will be affected negatively because the price control will cause a shortage in quantity supplied by the average Chinese worker; the price control employed by the government will restrict the resource costs needed by the workers in order to provide a certain good or service. The lack of revenue will force the farmers to raise other animals or harvest other products in order to gain a larger revenue.

    The free-market approach would eventually cause the market to reach equilibrium because firms will be forced to use the least-cost production, and until then consumers will purchase a substitute good to replace the original good, (eg. beef instead of pork).

  5. Jessica Ngon 26 Sep 2007 at 3:28 pm

    This is an example of a government intervention in an economy. In this case, a price ceiling is established by the government in order to "help" the consumers gain more consumption power. However, this as usual, although with good intentions in mind, will in fact have a negative effect on the economy. As producers are now forced to sell their products at a lower price in order to enable consumers to buy more, producers will soon "lose interst" in producing that certain product, in this case, pork. Instead, they might turn to other goods in order to earn a living. Thus, this creates a shortage of pork produced, creating a market disequilibrium, with ineffecient allocative resources. In turn, the Chinese people would get even madder at the government.

    If the Chinese government left the market alone in a laissez-faire policy, the market itself will return back to equilibrium through aspects of the market economy such as competition, forcing producers to allocate their resources effeciently at a minimum cost to produce maximum profit.

  6. Charlie.Gaoon 26 Sep 2007 at 7:47 pm

    What the government is doing here is a classic example of setting a price ceiling well below the equilibrium line. While the government is trying to do might be "good" in a sense, in that it's trying to help the consumers but this harms the producers because it is not making enough profit from the production price, thus lowering the supply.

    From what we learned so far, if China converted into a laissez faire policy, the market will slowly revert itself back to a state of equilibrium where MB=MC. The factors that will cause this reversion would be competition and the scarcity of resources, which forces these producers to allocate their resources efficiently.

  7. JenniferChoion 28 Sep 2007 at 2:02 pm

    It seems pretty clear that a price ceiling can hold inflation for a short period time, but obviously it will not help the situation in the long run. As angel said, this is becuase the suppliers will decrease their production, and because the demand remains the same, shortage of that product will decrease. The government in this case is not actually helping the consumers, but actually it is making the situation even worse for the poor consumers to obtain their products.

  8. Sakktion 30 Sep 2009 at 4:36 am

    This situation is very ironic, since by setting a price control, the government is trying to protect the consumers from high prices. In other words, they are trying to ensure affordable accommodation for the Chinese with low incomes. However, by just setting a price control, the government is not complete with their job of helping the consumers. They still have to decrease the demand (shift the demand curve to the left) in order to have an equilibrium in the economy. So, since they just froze the price, they are creating a very negative result in the big picture. The demand is increasing, while the supply is decreasing. This will cause shortages of the goods and services in the future due to the disequilibrium.

    Laissez-faire is a system in which there is no government intervention in the economy. This system might be handy for China in their current situation, since the firms will make their own decisions in how they will solve their problems. Firms will face short term opportunity-costs that will give them benefits in the long-run. By making a few sacrifices, they will gain more. The firms might look for substitute goods or simply decrease their prices in order to stay in business, since laissez-faire is basically capitalism, a system where firms compete with each other. Instead of focusing on equity, the new laissez-faire economy would focus on efficiency. Therefore the Chinese economy would eventually find its equilibrium and therefore inflation rates will decrease until the economy finds a stable state, where supply and demand are equal to each other.

  9. Nicolo' Fanellion 30 Sep 2009 at 11:50 pm

    The government’s price control might make the matter worse for the average Chinese indirectly through a series of event. First, if inflation increases, but the prices stay at the same level, this will limit the number of farmers able to cover their costs in the production of basic necessities. Thus not all will be able to make their products, since they cannot cover their costs and make profit, and this will result in fewer products available in the market, as one would rather not sell their product instead of making a negative profit. Thus, this will lead to a flaw of a market system, where only efficient firms, who can best cover their costs and still make profit at very low prices, will dominate the economy, whereas other firms will not be able to look after themselves and will not survive. Thus, this will lead to significant shortages in the market, due to excess demand and not enough supply, which will have an overall negative impact on the population. However, if this problem would be left to be faced by the free market, I believe this situation would be solved, as competition between companies would encourage them to continue producing efficiently and try to make profit while having to pay the least costs for their outputs. Competition between companies will finally result in a new market-clearing price and this will not change if no further ‘outside disturbance’ is brought to the economy. Moreover, a company should sell its stored products, if any were stored (though not many as food is perishable).

  10. Noraon 01 Oct 2009 at 12:01 am

    Although the government is imposing these price controls to calm people’s anger about inflation, they are actually disturbing the natural flow of the self- adjusting free market economy. With the prices set, some firms will not be able to cover their production costs and will therefore lose money or not sell at all. This will decrease the number of producers in the market, which is a determinant of supply. The government intervention will cause product shortages because the quantity demand will rise because of lower prices, but the supply will decrease.

    If China’s economy were left on its own, the competition between producers will eventually cause the prices to decrease by themselves until the equilibrium price and the equilibrium quantity supplied is reached. This way there will be no shortages and no surpluses.

  11. Hannaon 01 Oct 2009 at 12:10 am

    The government’s price controls might actually make the matter worse for the average Chinese because the government sets a maximum price which is below the equilibrium price for certain products. This leads to a problem because when the price of a product is lowered, the demand for the product will rise but the firms are not able to supply enough (because they wouldn’t be able to make profit) to meet the needs of the consumers’ demand. This could result in the emergence of a black market, where the product would be sold at a higher price than the one the government set. So, although the government is trying to help the Chinese by lowering the prices of certain products, it will only do harm in the long-run.

    If the government were to take a laissez faire approach to the inflation problems faced by China, then the problems would most likely be resolved on their own. The free market would create competition between firms which would cause an equilibrium price being set, because firms will decide upon the prices of their products based on what other firms are selling their products for, and also based on the demand of the Chinese population.

  12. Christopheron 01 Oct 2009 at 3:55 am

    What the government has done here is to put a maximum price on the products sold, therefore when some of the more expensive firms want to sell their product for an amount above the maximum price they won’t be able to and therefore won’t be able to cover their initial costs for the production of the product therefore firms will go out of business and many Chinese employees will lose their jobs. It will also cause a black market to appear because the quantity offered is not enough and the black market for that product will emerge being able to give away that product but for a higher price.

    The laissez faire approach would lead to many companies being created in order to gain profit from selling food. This would then lead to competition and then with competition an equilibrium of Quantity demanded and Quantity supplied giving a low price.

  13. Sarah Ebleon 01 Oct 2009 at 5:15 am

    The government’s price controls make the matter worse for the average Chinese because the fixed price is under the equilibrium price. This means that the demand for the product rises while the supply decreases. If the price stays the same, but the costs for producing the product are going up, there will be a shortage of the product.

    If the government were to take a “laissez faire” approach to the problems, then the demand and the supply would regulate themselves: Producer could set the price to where they need in order to still be able to produce enough and at a level where it is profitable and consumers could see if they were willing and able to pay the price for the product. This would lead to competition and a set an equilibrium.

  14. Pilaron 01 Oct 2009 at 5:02 pm

    1. Why might the government’s price controls actually make the matter worse for the average Chinese?

    The government's price controls actually make the matter worse for the average Chinese because if the price is under the equilibrium the demand will increase resulting in a decrease of supply. This might be good for the Chinese consumers but for Chinese producers not really. Chinese producers might get stressed if their costs for production of products is greater than the actual income of these product.

    2. If the government were to take a “laissez faire” approach to the problems faced by China, how might the free market resolve them on its own? Any ideas?

    If the government were to take a "laissez faire" apporach to the problems faced by China, I think that the free market would work. The producers were to be free to set their own prices.

    Demand and supply would adjust the prices and so the free market economy would work for consumers and producers to meet their own needs.

  15. Vincenton 01 Oct 2009 at 5:18 pm

    1.Why might the government’s price controls actually make the matter worse for the average Chinese?

    In the long run, Inflation cannot be held up by price regulation of the government. If the government keeps the price low, the demand increases, causing an even greater shortage and a bigger increase of the price in the future. The manufacturers cannot produce much more efficient than they are right now. If the government tries to keep the price low, it either has to support the firm financially or they will finally have to close down. So, as long as the supply of pork stays low, the price has to increase. Consumers must change their preferences towards substitute goods.

    2.If the government were to take a “laissez faire” approach to the problems faced by China, how might the free market resolve them on its own? Any ideas?

    If the government used “laissez-faire“, the demand and supply would regulate itself, meaning an increase in price would lead to a decrease in demand (inverse relationship) and a consumer change in preferences towards other products. That would give the firms time to increase their production.

  16. Silvia Dieteron 04 Oct 2009 at 7:50 pm

    1. The governments price controles makes it worse for the average Chinese people. The government sets a fixed price which is under the equilibrium. Therefore the demand for the product increases while the supply decreases. However when the productions costs of a product increase even when the price of the product says the same, there will be a shortage in the product.

    2. If the government were to take a "laissez-faire" approach to the problems faced by China, demand and supply would regulate themselves. Firms start to compete against each other and decides upon their price, depending on their product, the price other firms sell their products and the demand of Chinese people. Therefore a equilibrium price is most likely being set.

  17. kvoskuilon 05 Oct 2009 at 5:21 am

    The government is trying to make goods and services for many Chinese people affordable, they do this though constant prices, no price increases allowed. At first this seems all fine, but when stepping back you realize that the government is making a huge mistake with supply and demand. Since the price is constant the demand will increase but the supply will not be able to catch up. This will be a huge problem because there will be a excess demand and a shortage in supply, meaning the economy will never turn into equilibrium again.

    If the government took a “laissez faire” approach to the problem then it will most likely be resolved. The economy will restore itself because the of the supply and demand laws. Sometimes firms need to make sacrifices in the short term to improve the long term, for example, lower the price so many consumers buy their good. Competition will drive the price down making many good s more affordable to the average Chinese. Then the economy would slowly restore itself.

  18. Lara Fuhrmannon 23 Oct 2009 at 3:25 am

    1.Why might the government’s price controls actually make the matter worse for the average Chinese?

    The government's price control makes it worse for the average Chinese, because the will set a price ceiling which is below the equilibrium. This will lead to a disequilibrium so the quantity demanded would be more than the supply for that product. This will lead to a shortage.

    2.If the government were to take a “laissez faire” approach to the problems faced by China, how might the free market resolve them on its own? Any ideas?

    If the government were to take a "laissez faire" approach, the demand and supply would lead to a disequilibrium. Because the firms would compete against each other, making the prices higher or lower and the consumers couldn't aford this much money and will be going to cheaper products. The economy will restore itself and an equilibrium has to be set by the government, so it was all pointless.