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价格管制 A Theory of Price Control Steven N. S. Cheung Journal of Law and Economics, Vol. 17, No. 1. (Apr., 1974), pp. 53-71. Stable URL: http://links.jstor.org/sici?sici=0022-2186%28197404%2917%3A1%3C53%3AATOPC%3E2.0.CO%3B2-2 Journal of Law and Economics is curre...

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A Theory of Price Control Steven N. S. Cheung Journal of Law and Economics, Vol. 17, No. 1. (Apr., 1974), pp. 53-71. Stable URL: http://links.jstor.org/sici?sici=0022-2186%28197404%2917%3A1%3C53%3AATOPC%3E2.0.CO%3B2-2 Journal of Law and Economics is currently published by The University of Chicago Press. Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.html. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/journals/ucpress.html. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is an independent not-for-profit organization dedicated to and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support@jstor.org. http://www.jstor.org Wed Apr 11 21:42:00 2007 A THEORY OF PRICE CONTROL* STEVEN N . S. CHEUNG University of Washington PRICEor rent control is but one of many forms of legislative action which interfere with private contracting in the market place. To delimit the scope of my analysis, I shall use the term "price control'' to refer only to any set of regulations which satisfies the following three conditions. First, the control must fix the price (or income)l terms of private contracts; this categorically excludes any laws which regulate the distribution of income among the con- tracting parties on a share or percentage basis2 Second, the control must involve no appropriation of proceeds to or from the government; taxation and subsidization are thus excluded. Finally, the fixing of price must not be associated with direct government sales, purchases, or manipulation of re- sources so as to maintain the regulated price;3 by this stipulation, price "support" is also excluded. Even on such terms, legal regulations to control price are still many and varied. To evaluate our understanding of the class of phenomena which we seek to explain i t is essential that we discover implications refutable by facts. By this criterion the available body of economic theory pertaining to price control is deficient indeed: the massive literature on the subject offers few such implication^.^ An alternative approach to analyzing the observable effects of price control is presented here. *This paper stems from an elaborate investigation of the various phases of rent control in Hong Kong from 1921 to 1972. Thanks are due to Yoram Barzel, R. H. Coase, Harry Johnson, Michael Rahm and A. A. Walters for their comments, and to the National Science Foundation for supporting my research in the general area of contracts. 1By income terms of contracts I refer here to the terms of payments designed to stipulate the distribution of income (or wealth) among the contracting parties. We will discuss this further later. 2 Regulation on a percentage basis may be imposed on commission rates, dividends, or the sharing percentage of a share contract. Because these control a parameter without a dollar dimension, the associated analysis is simpler. See, for example, Steven N. S. Cheung, The Theory of Share Tenancy, chs. 5 & 6 (1969). 3For example, we exclude such situations as maintaining a regulated taxicab fare by restricting the number of medallions, or supporting the pegged price of corn by restricting the amount of land devoted to its cultivation. 4 There are, however, economic studies which deal with the social desirability of price control and others which estimate the effects of price control. These writings may indeed THE JOURNAL OF LAW AND ECONOMICS Demand and supply schedules are conceptual tools which restrict the maximum quantities of a good individuals are willing to buy or sell a t varying prices. With all the underlying qualifications, we are able to arrive a t situa- tions where the observed prices and quantities transacted are said to be determined and where these in turn determine income distribution and resource allocation. As a corollary, specified changes in demand and supply conditions will lead to implied changes in the transacted prices and quantities. But as they stand, these conceptual tools are not equipped to handle a situation where the price which they are designed to determine is controlled. As an illustration, consider a case where the $10 market price of a theater ticket is reduced by law to $6. A "shortage" is then said to exist, and the plausible effects are many. Available tickets might be allocated by a wide variety of methods including waiting in queue, "friendship" with the ticket seller, different forms of rationing, or even physical violence. Alternatively or concurrently, "black" markets of various shades might emerge, the quality of the show might be allowed to deteriorate in a number of ways, or as still another possibility the curtain might go down altogether. Any of these events, or combinations of events, would be consistent with a shortage. But what observation can refute that "shortage" hypothesis? None! If, for example, we observe that queues are not longer or even shorter under the control, the existence of a "shortage" is not necessarily falsified. Nor does the hypothesis contain the weaker, but still useful, type of implication which states that the control will lead to a restricted set of events, since the list of events feasible under a shortage is prohibitively long. A theory potentially consistent with everything explains nothing. I t is frequently said that under price control the market will not clear. A market exists whenever a transaction is made between two or more indi- viduals, and the terms need not be confined to a monetary price. I t is true that price control may generate a different criterion, or a combination of criteria, such as allocation by waiting, by seniority, by height, or by strength. Yet given whatever criterion of allocation, and that market transactions con- tinue to exist under the control, the market will necessarily clear in the sense be of interest in contributing to our knowledge of price controls in general. For a few examples see Seymour E. Harris, Price and Related Controls in the United States (1945) ; William D. Grampp, Some Effects of Rent Control, 16 So. Econ. J. 425 (1950) ; D. Gale Johnson, Rent Control and the Distribution of Income, 41 Am. Econ. Rev. No. 2, at 569 (Papers & Proceedings, May 1951); J. L. Carr, Rent Control and Housing Policy, 64 Econ. J. 25 (1954) ; John Sbeahan, Problems and Possibilities of Industrial Price Control: Postwar French Experience, 51 Am. Econ. Rev. 345 (1961); Ira S. Lowry, Joseph S. DeSalvo & Barbara M. Woodfill, 2 Rental Housing in New York City (New York City Rand Institute, 1971). A THEORY OF PRICE CONTROL 5 5 that the quantity demanded will equal the quantity supplied. The simple mechanism will be illustrated later. I t is also true that price control may cause changes in the quality of the good transacted or that transactions which would have occurred in a free market now cease to occur. Again, in any case the market will necessarily clear. Even if we take the extreme case where transactions in a particular good are completely eliminated by the price control, the "clearing" of the market is identical to that of any other in which trading ceases: given the constraints the contracting parties no longer find any transaction of the good worthwhile. In each of these cases, previous theory is incapable of predicting which of the alternatives will occur, but to say that the market "does not clear" is simply to sidestep an unresolved question. I n an analysis where price control is said to result in "disequilibrium," refutable implications are absent. Merely to say that the price of a good or the rental value of a property is by law set above or below the market price is not sufficient to produce any predictable outcome. When additional con- straints are specified, however, behavior becomes more restricted. To inter- pret the effects of price control, as to interpret any economic behavior, the specified constraints must be rigid enough to yield implications refutable by facts. Some writers on price control, apparently perceiving the futility of treat- ing the problem in terms of ('disequilibrium7" have met the issue by assuming, implicitly or explicitly, some given constaints sufficient to yield an equilibrium ~olu t ion .~Since they failed to investigate actual constraints, their imaginary restrictions were devoid of empirical content and have produced hypotheses interesting only as intellectual exercises and incapable of explaining real- world phenomena. If certain outcomes are to be attributed to the control, the constraints specified must conform essentially to those in real practice. Given the usual complexity of any effective price control, and that one control usually differs from another, it is highly unlikely that the actual constraints can be guessed correctly. Furthermore, the use of imaginary constraints will easily lead to ad hoc theorizing. The imposition of a particular set of con- straints, if sufficiently comprehensive, will naturally yield a particular set of implications. But it is always possible to pick and choose among these con- For a few examples of such works, see K. E. BouIding, A Note on the Theory of the Black Market, 13 Can. J. Econ. & Pol. Sci. 115 (1947) ;M. Bronfenbrenner, Price Control Under Imperfect Competition, 37 Am. Econ. Rev. 107 (1947) ; id., Price Control Under Imperfect Competition: The Joint Production Problem, 15 Can. J. Econ. & Pol. Sci. 210 (1949); Michael Michaely, A Geometrical Analysis of Black Market Behavior, 44 Am. Econ. Rev. 627 (1954); Emre Gonersay, The Theory of Black Market Prices, 33 Eco- nornica 219 (n.s. 1966) ; and J. R. Gould & S. G. B. Henry, The Effects of Price Control on a Related Market, 34 Economica 42 (ns. 1967). 5 6 THE JOURNAL OF LAW AND ECONOMICS straints so that, when confronted with adverse evidence, a favorite hypothesis can be salvaged by altering or further specifying the constraints involved. The central problem in interpreting the effects of price control is therefore the one common to all empirical economic inquiry. On the one hand the specification of constraints requires an investigation of the real-world situa- tion; on the other, the investigation itself must be guided or restricted by some theoretic framework. The latter condition is essential in the inevitable process of sorting out the relevant constraints from the irrelevant, the signifi- cant from the insignificant, so that the consequent effects subject to refuta- tion can be restrictively implied. In other words, a theoretic framework which restricts our freedom in choosing and simplifying the constraints is essential to guard against ad hoc theorizing, or letting the facts speak for themselves. The necessity of a theory to govern the investigation and specification of constraints appears to be more imperative in the case of price or rent control than with other forms of government regulations. To fix the price terms of market contracts by law while not setting any standard rules to govern the appropriation of proceeds and allocation of resources leaves a wide-open range of constraints that may be relevant for decision making. Effective price controls vary from time to time and from place to place, they entail immense bodies of regulations and administrative enforcements, and they involve con- straints on behavior not limited to legal provisions. Furthermore, as with any empirical inquiry, no study of finite length could possibly incorporate in detail all the relevant constraints. Simplification is necessary, but the greater the simplification, the fewer and less specific will be the derivable implica- tions. While the emphasis and the abstraction of constraints are left to the discretion of the economist, his selection must be consistent with a given theoretic framework. The theory of price control offered here is, therefore, not intended to ex- plain the effects of any specific control. Rather, i t sets forth some general propositions about the way in which the constraints relevant to any price control may be investigated. These propositions, in turn, are restricted by the requirement of conformity to standard economic principles. 11. Two GENERAL FOR PRICE CONTROL PROPOSITIONS ANALYSIS As noted earlier, price control restricts the income terms of private con- tracts. The right to contract implies that the resources involved are, a t least to some degree, exclusively owned. I t is, therefore, pertinent to derive our propositions through an examination of some aspects of property rights and contracting. An economic good embodies a set of characteristics subject to legally or A THEORY OF PRICE CONTROL 57 customarily defined limits. A good or an asset is "private property" if, and only if, three distinct sets of rights are associated with its ownership. First is the exclusive right to use, or to decide how to use, the good; this may be viewed as the right to exclude other individuals from its use. Second is the exclusive right to receive income generated from the use of the good. Finally, the right to transfer, or freely alienate, its ownership to any individual the owner sees fit includes the right both to enter into contracts with other individuals and to choose the form of such contracts. Within the realm of economic principles, these rights are specifically interrelated. A restriction imposed on the right to receive income, as in the case of price control, will yield predictable changes in behavior in the exercise of the other two sets of rights. By postulate, each individual will utilize his private property in such a way as to generate the highest real income. He may either employ the good or the resource himself in what he believes to be its most valuable use: or enter into contractual arrangement with another individual to attain this use. Given the distribution of wealth and the portfolios of asset-holdings chosen by individuals, much is to be gained from forming contrack7 Thus, the value of a good will decline either if its most valuable use is restricted, or if its trans- ferability, in one way or another, is constrained by law. A free market, by definition, requires not only the absence of legal regulation on contractual terms but also the absence of restriction on the choice of contracts. In making a contract, the owner of a good forgoes some or all rights to its use in exchange for income. Depending upon the form of contract chosen, the distribution of income may not be stated in terms of a unit price, but price control is applicable to any contract so long as the income receivable by one or more of the contracting parties is regulated to a fixed amount. While every contract necessarily entails an agreement on the distribution of income (or wealth), not all contracts stipulate the use of the resource itself. When a good is transferred outright under caveat emptor in return for full and immediate payment, no such restrictions will be present. However, other contracts (such as for wages or rental) involve only a transfer of some of the use rights to a good for a period of time. Containing implicit or explicit use 6 No distinction is made here among a good, an asset, a resource, or a factor of produc- tion, so long as they satisfy the definition of an economic good. ?The gains from contracting are a complicated subject. For our present purpose it is sufficient to recognize that such gains exist. For fuller discussions see R. H. Coase, The Nature of the Firm, 4 Economics 386 (n.s. 1937) ; id., The Problem of Social Cost, 3 J. Law & Econ. 1 (1960) ; Steven N. S. Cheung, Transaction Costs, Risk Aversion, and the Choice of Contractual Arrangements, 12 J. Law & Econ. 23 (1969); Armen A. Alchian & Harold Demsetz, Production, Information Costs and Economic Organization, 62 Am. Econ. R&. 777 (1972). 58 THE JOURNAL OF LAW AND ECONOMICS stipulations that vary with the physical attributes of the good and with the form of contract chosen, such a contract will involve a structure and will exist over a period of time.8 A price control which regulates a contract of this nature (as in the case of rent control) acts on the flow of income. Let us turn to our first proposition. Proposition 1: When the right to receive income is partly or fully taken away from a contracting party, the diverted income will tend to dissipate un- less the right to it is exclusively assigned to another individual. The dissipation of non-exclusive income will occur either through a change in the form of using or producing the good, resulting in a decline in its value, or through a change in contractual behavior, resulting in a rise in the cost of forming and enforcing contracts, or through a combination of the two. Under the postulate of constrained maximization, the loss of exclusive right to receive income from the use of a good will lead to the same sort of behavior as though the right of use were non-exclusive. That is, the individual will not exercise his prerogative because he is denied the right to income from the use. He will have no incentive to contract with others and to stipulate the use of a good or a resource if he cannot derive any exclusive income from that contract. Furthermore, he will have no incentive to use his resource as if it were private property, or to exclude others from its use. For example, if all income-pecuniary or nonpecuniary-derivable from a privately owned fish- ing ground is effectively reduced to zero, although the use rights remain exclusive, its utilization will be identical to that of another fishing ground lacking exclusive-use rights. By parallel reasoning, a partial attenuation of the exclusive right to receive income will operate in the same way as a partial attenuation of the exclusive right to use. Before we discuss why price or rent control will generate non-exclusive income, i t is helpful to consider the fairly familiar thesis of the dissipation of "rent" for a "common" property resource, frequently exemplified by the case of a f i ~he ry .~ If no one holds exclusive rights to use a resource, the thesis 8That some contractual stipulations are not stated, either orally or in writing, poses another issue which will not be elaborated here. While the presence of contracting costs will lead to omissions of stipulations, common laws or customs will avoid the necessity of setting forth many terms which would otherwise be explicitly stated. For a fuller dis- cussion of a structured contract, see Steven N. S. Cheung, The Structure of a Contract and the Theory of a Non-Exclusive Resource, 13 J. Law & Econ. 49 (1970): 9 An early major contribution to this thesis is in Frank H. Knight, Some Fallacies in the Interpretation of Social Cost, 38 Q.J.Econ. 582 (1924). The extension of the Pigou- Knight example from that of two roads to that of a hhe ry is seen in H. Scott Gordon, The Economic Theory of a Common Property Resource: The Fishery, 62 J. Pol. Econ. 124 (1954). The mechanism of the dissipation of rent is discussed in Cheung, supra note 8. A THEORY OF PRICE CONTROL 59 tells us, any rent which would have accrued from its exclusive use will be dissipated
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