Price Controls Destroy Coasean Bargains
A useful way to think about price controls is that they destroy mutually beneficial Coasean bargains. By a “Coasean bargain,” I mean an offer that takes the following form: “I’ll pay you to reduce this harm” or “I’ll compensate you for bearing this harm.”
Consider minimum wage as an example of the former instance. Imagine factory workers on a hot summer day making $7.25 per hour. In a free market, they (could) strike the following deal with their employer: “We’ll go down to $7 per hour if you install AC.” Assuming that AC is sufficiently cheap, it’s a win-win. Workers get the AC, which they value more than 25 cents per hour, and the employer saves more on his wage bill than he expends on his AC bill. In essence, the workers are saying: “We’ll pay you to remove this harm.”
Except, the minimum wage prevents wages from falling to seven dollars. A mutually beneficial exchange fails to materialize.
Now, consider a price ceiling. Here, the Coasean bargain takes the form of: “I’ll compensate you for bearing this harm.” Imagine a landlord who hates the sight of brown-haired folk (such as myself).
A brown-haired person could say: “I know the going rate for this apartment is a thousand bucks/month. But I’ll pay you $1,200 per month since I know how you disdain the brown-haired.” In other words: “I’ll pay you to bear this harm.”
In a free market, it’s a win-win. The brown-haired buyer gets an apartment he values more than $1,200 monthly. The bigoted tenant is willing to accept $200—just enough to overcome his prejudice.
Except, rent control prevents buyers from paying more than $1,000 per month. A mutually beneficial exchange fails to materialize.