Why might some managers want price controls?

Why wouldn't they get together

and control prices themselves (if it were legal)?

Some managers would want price controls because to restrict the upward movement of
prices because it would create a shortage, thus raising the effective price of the product
and creating higher demand (see Appendix 1). The lowered price and product shortage
will cause consumers to wait in long lines and accept sub par quality product. Some
managers with less than ethical business practices may wish to take advantage of this lack
of consumer control in the market. They may cut corners in the creation of their product
saving themselves money. They can also tie in the price of an uncontrolled good with a
controlled product, which would raise the price of the uncontrolled product (McKenzie &
Lee, 2006).
Not all managers would be open to these unscrupulous business practices. If it were legal
for managers to band together for the purpose of price control some would resist. This
resistance would be in part because if one company initiated unethical business practices
to raise the profit of their firm then others would have to follow suit in order to remain
competitive in the market. It would also be difficult for a large group of managers to find
a common interest based on the large group theory (McKenzie & Lee, 2006). Some
would have the self-interest of profit for the firm as motivation, while others would want
to benefit the consumer with the price controls.



The existence of external costs is not in itself sufficient reason for government
intervention in the market. Why not?

As stated by the authors the economic distortions created by externalities are often quite
small, and the act of the government being involved creates externalities of its own. Thus
the government in essence internalizes external costs. This can cause both good and bad.
The market should be looked at as a whole. Do the externalities influence the market
negatively against those countries producers, if so how much? Many other questions
should be addressed as well, some of them being what would the impact on the
relationship between the two markets, and i.e. would the other country impose taxes on
our goods going into their countries, thus having a ripple effect. This might hurt out
economy more than the fix by the government in the first market would help, canceling it
out and possibly added difficulties in numerous markets with in our country. This might
be overcome if the original market employed many people and that unemployment would
certainly need to be considered. Other things to consider would be by imposing a tarrif or
by assuming ownership of that industry.
Certainly in some instances like water, power or emergency services the common good or
benefit to all would certainly outweigh other externalities and government involvement
would be welcomed. However in most free markets there are many externalities both
tangible and containable along with added internal costs that would certainly push any
positive effect from government intervention and make it a negative impact proposition.
Thus many things need to be considered and more often than not government
involvement is not warranted and would be detrimental in the long run.
If a tariff is imposed on imported autos and the domestic demand for autos rises, what
will happen to auto imports? If a quota is imposed on imported autos and the
demand for autos increases, what will happen to auto imports?


Rising Prices

Suppose you have sugar imported freely in a country and accounting for 50
percent of the total sugar market. If the government imposes a quota on sugar imports,
then the total sugar supply in the market will drop. The excess demand will drive prices
up, giving a blow to consumers' purchasing power. Unless domestic production manages
to cover demand, then the sugar price can remain high indefinitely.
Boost of Domestic Production

Domestic production has to cover the gap in the market foreign products used to
occupy. When quotas decrease the import of sugar from, say, 5 lb. per person to 2 lb.,
then domestic sugar producers have to increase their work rate and provide those 3 lb. to
consumers. This fact is especially helpful for domestic industries lacking not the
capabilities, but the incentive -- due to competition with cheaper foreign products -- to
produce and subsequently earn more.
Effects on Multinational Corporations

Import quotas have a direct negative effect on multinational corporations. Such
enterprises, such as Nike and General Motors, place emphasis on international trade, as
domestic consumption cannot cover their high targets. For example, in 2008, out of the
approximately 7 million total vehicle sales of General Motors, only approximately 3
million was in the U.S. In the event of an import quota by a major buyer, multinational
corporations must quickly find alternative markets or cut down production, along with
subsequent profits.
Promoting Wrong Economic Orientation

The main goal of import quotas is to protect an industry that in the free market is
doomed to fail against international giants. Therefore, such measures are like putting
hobbling industries on life support. However, this way governments emphasize evidently
weak industries instead of supporting sectors where domestic producers can thrive. For
example, the United States cannot compete with China in clothes production, but it can
focus on keeping the upper hand in the computer software industry.
20







If the major domestic auto producers are given a bailout for their financial troubles
(as they were in 2009 in the United States), what will be the market effects on
domestic and foreign auto producers?
Claims that failure would be harmful to economy[edit]
The auto industry is a key component of the U.S. economy. Economists used 20072008
data to build estimates of what a shutdown would cost in summer 2008, in order to set
benchmarks to help policy makers understand the impact of bankruptcies. Such estimates
were widely discussed among policy makers in late 2008.
[45]
Closing the Big Three
would mean loss of 240,000 very highly paid jobs at the Big Three,
[46]
a loss of 980,000
highly paid jobs at the suppliers and local dealers, plus the loss of 1.7 million additional
jobs throughout the economya total loss of 3 million jobs.
Estimates were that a Big Three shutdown would cause a decline in personal income of
$151 billion the first year, and $398 billion over three years. The federal, state and local
governments would lose tax revenue, and instead spend on welfare programs a total of
$156 billion over three years.
[47]

Economist David Wyss of S&P has posited that if GM and Chrysler disappear, there
could be an increase of about 1 million imported cars every year, which would remove
about $25 billion from the U.S. economy. That would reduce GDP by 0.2 percentage
points annuallyexcluding the impact of lost jobs (higher unemployment) and wages.
[48]

Claims that failure would not be harmful to economy[edit]
In a November 19, 2008 CNBC article, Jordan Kimmel, a fund manager at Magnet
Investing in Randolph, New Jersey, said that if the Big Three automakers were liquidated
or completely shut down, foreign companies such as Honda and Toyota would open up
new manufacturing plants in the U.S., and there would be no long term loss in
employment or damage to the economy.
[49]

Michael Schuman of Time Magazine stated that although a giant corporation failing
would be ugly, it is better than artificially keeping it alive without a prospect of
improvement. He compared the possible collapse of the U.S. domestic automakers to the
1999 dismantling of the Daewoo Group in South Korea. Daewoo's proportionate
economic impact on Korea was larger than that of the Big Three to the United States. The
persistence of the belief that Daewoo and other Korean conglomerates were too big to fail
led many bankers and investors to continually waste money on bailouts, despite their
poor business plans and unprofitable projects, as Daewoo was unable to repay these
loans. Once the too-big-to-fail perception was dispelled, with large conglomerates no
longer considered the safest investments, bankers and investors began financing new
opportunities in areas which had been starved of capital (small firms, entrepreneurs and
consumers), while Korea's GDP actually rose after Daewoo's unwinding. Schuman also
noted a similar analogy with Japan during its Lost Decade of the 1990s, where banks kept
injecting new funds into unprofitable "zombie firms" to keep them afloat, arguing that
they were too big to fail. However, most of these companies were too debt-ridden to do
much more than survive on further bailouts, which led to an economist describing Japan
as a "loser's paradise." Schuman states that Japan's economy did not begin to recover
until this practice had ended


The intervention on GMs behalf denied the spoils of competition the market share,
sales revenues, profits, and productive assets to Ford, Honda, Hyundai, and all of the
other automakers that made better products, made better operational decisions, were more
efficient, or were more responsive to consumer demands than GM, thereby short-
circuiting a feedback loop that is essential to the healthy functioning of competitive
market economies.
Corporate bailouts are clearly unfair to taxpayers, but they are also unfair to the
successful firms in the industry, who are implicitly taxed and burdened when their
competition is subsidized. In a properly functioning market economy, the better firms
the ones that are more innovative, more efficient, and more popular among consumers
gain market share or increase profits, while the lesser firms contract. This process ensures
that limited resources are used most productively.


Because the balance of payments must always balance, how can a disequilibrium
situation occur?
The Balance of Payments is comprised of two main components:
The Current Account (trade in goods, services + investment incomes). The
Financial Account (used to be called capital account; this is capital flows such as
foreign direct investment)
If the UK imports more goods and services than we export then we have a deficit on the
current account. A significant deficit on the current account is generally referred to as
disequilibrium. It will be matched by a surplus on the financial account.


Cyclical Disequilibrium:
It occurs on account of trade cycles. Depending upon the different phases of trade cycles
like prosperity and depression, demand and other forces vary, causing changes in the
terms of trade as well as growth of trade and accordingly a surplus or deficit will result in
the balance of payments.

Cyclical disequilibrium in the balance of payments may occur because:
i. Trade cycles follow different paths and patterns in different countries. There are no
identical timings and periodicity of occurrence of cycles in different countries.
ii. No identical stabilisation programmes and measures are adopted by different countries.
iii. Income elasticities of demand for imports in different countries are not identical.
iv. Price elasticities of demand for imports differ in different countries.
In short, cyclical fluctuations cause disequilibrium in the balance of payments because of
cyclical changes in income, employment, output and price variables. When prices rise
during prosperity and fall during a depression, a country which has a highly elastic
demand for imports experiences a decline in the value of imports and if it continues its
exports further, it will show a surplus in the balance of payments.
Since deficit and surplus alternatively take place during the depression and prosperity
phase of a cycle, the balance of payments equilibrium is automatically set forth over the
complete cycle.
ii. Structural Disequilibrium:
It emerges on account of structural changes occurring in some sectors of the economy at
home or abroad which may alter the demand or supply relations of exports or imports or
both. Suppose the foreign demand for Indias jute products declines because of some
substitutes, then the resources employed by India in the production of jute goods will
have to be shifted to some other commodities of export.
If this is not easily possible, Indias exports may decline whereas with imports remaining
the same, disequilibrium in the balance of payments will arise. Similarly, if the supply
condition of export items is changed, i.e., supply is reduced due to crop failure in prime
commodities or shortage of raw materials or labour strikes, etc. in the case of
manufactured goods, then also exports may decline to that extent and structural
disequilibrium in the balance of payments will arise.
Moreover, a shift in demand occurs with the changes in tastes, fashions, habits, income,
economic progress, etc. Propensity to import may change as a result. Demand for some
imported goods may increase, while that for certain goods may decline leading to a
structural change.
Furthermore, structural changes are also produced by variations in the rate of
international capital movements. A rise in the inflow of international capital tends to have
a direct impact on a countrys balance of payments.
iii. Short-run Disequilibrium:
A short-run disequilibrium in a countrys balance of payments will be a temporary one,
lasting for a short period, which may occur once in a while. When a country borrows or
lends internationally, it will have short-run disequilibrium in its balance of payments, as
these loans are usually for a short period or even if they are for a long duration, they are
repayable later on; hence the position will be automatically corrected and poses no
serious problem.
As such, a disequilibrium arising from international lending and borrowing activities is
perfectly justified. However, a short-run disequilibrium may also emerge if a countrys
imports exceed its exports in a given year.
This will be a temporary one if it occurs once in a way, because later on, the country will
be in a position to correct it easily by creating the required credit surplus by exporting
more to offset the deficit. But even this type of disequilibrium in the balance of payments
is not justified, because it may pave the way for a long-term disequilibrium.
When such disequilibrium (arising from imports exceeding exports or even vice versa)
occurs year after year over a long period, it becomes chronic and may seriously affect the
countrys economy and its international economic relations. A persistent deficit will tend
to deplete its foreign exchange reserves and the country may not be able to raise any
more loans from foreigners.
iv. Long-run Disequilibrium:
The long-term disequilibrium thus refers to a deep- rooted, persistent deficit or surplus in
the balance of payments of a country. It is secular disequilibrium emerging on account of
the chronologically accumulated short--term disequilibria deficits or surpluses.
It endangers the exchange stability of the country concerned. Especially, a long-term
deficit in the balance of payments of a country tends to deplete its foreign exchange
reserves and the country may also not be able to raise any more loans from foreigners
during such a period of persistent deficits.
In short, true disequilibrium is a long-term phenomenon. It is caused by persistent deep-
rooted dynamic changes which slowly take place in the economy over a long period of
time. It is caused by changes in dynamic forces/factors such as capital formation,
population growth, territorial expansion, technological advancement, innovations, etc.
A newly developing economy, for instance, in its initial stages of growth needs huge
investment exceeding its savings. In view of its low capital formation, it has also to
import a large amount of its capital requirements from foreign countries and its imports
thus tend to exceed its exports. These become a chronic phenomenon. And in the absence
of a sufficient inflow of foreign capital in such countries, a secular deficit balance of
payments may result.




Consider the following production capabilities of France and Italy for cheese
and bread for a given use of inputs. Which nation will export cheese to the
other? What might be a mutually beneficial exchange rate for cheese and
bread?
Cheese units Bread units
France 40 or 60
Italy 10 or 5

i.e
Cheese Bread
France 40 60 1 cheese costs 1.5 bread

Italy 10 5 1 cheese costs 0.5 bread


Mutually beneficial is 1 bread = 1 cheese (1.5 0.5)