Flooring the Market

Akshita Manocha Words of Freedom Leave a Comment

Last Thursday we asked you if there should be a minimum price fixed by the government below which a supplier should not be allowed to sell a good or a service as airline companies sometimes do.

70 % of you disagreed to minimum price control by the government, while 30 % of you wanted the government to set floor prices for goods and service providers.

Businesses run on profit. Nobody who is in business would like to run it to lose money. If they did so, their business will not be sustainable. Therefore business strategies, including price fixing, can be accurately devised by those who have the requisite skill, knowledge of the product and the market, and experience of running a business. When somebody else takes up that job, as the government does when it controls prices, it invariably leads to the detriment of the consumer. But why should it when the government says it controls price to protect the consumer?

The government controls price when enterprises indulge in unfair trade practices. Unfair trade practices are fraudulent or unethical practices to run a business and earn profits. The government intervenes when it suspects either cartelization or predatory pricing methods. The airline example in the poll question relates to an alleged unfair pricing method termed as predatory pricing. Predatory pricing is a pricing strategy in which an entity lowers the price of its product to such an extent that all the consumers take the products of this entity while other entities, which are unable to enter the price war, are driven out of business due to lack of takers for their products. The assumption is that a larger business enterprise has the capital to sell its products below cost price and yet survive in the short run. This is to exploit consumers’ preference for cheap products to deprive smaller enterprises who cannot lower their price of business. Once competition is killed and monopoly or near monopoly established thus, the larger business will go back to charging higher prices for its products, in effect taking the consumer for a ride. But how far is this theory true?

Economists consider predatory pricing to be a myth due to its impracticality.

A producer makes a product with the paying capacity of their target consumers in mind. So consumers of a product generally know when a price is for promotional purpose only. Even if a business expands its consumer base by attracting new customers who can pay only less than the true value of its products, it cannot retain such customers once they raise their prices. Therefore a business whose objective is to make profits may introduce low or even rock bottom prices as a promotion strategy for a short period of time, but only for a short period of time. Unless the business finds an innovative method to cut cost and keep the price low in which case fixing a minimum price above such a low price will amount to forcing the consumer to pay more than what a commercial supplier wants for its product.

Perhaps the finest example of an innovative enterprise that has built an empire by cutting costs is Walmart. If low pricing could be maintained only by cash rich companies, that too only for a short period of time as supporters of price control suggest, Walmart should have gone out of business decades ago. Yet it has been making millions in profits since 1962 by providing cheapest of products and continuing to provide cheapest of products. These profits have pushed them to innovate and create the world’s most reliable mechanisms to procure and distribute goods. If the government had intervened and stalled their growth, Walmart would not have gone on to provide the estimated 2.2 million people a job or to millions of customers around the world an opportunity to consume the best products their money can buy.

This is not to say that it is wrong to want a level playing field for businesses or fairness and accountability in markets. It is only to say that fixing a floor price is not an adequate way to bring about fairness in the market. When a few producers collude to decide on a price below which others are not allowed to sell their products is, it is called cartelization. However, when in the garb of imposing fair trade practices such prices are set by the government or government authorized agencies it is considered just. Different prices are a characteristic of a competitive market. The advantage of deciding the price by the interaction of demand and supply is that the consumer gets the right to choose a cheaper product. The consumer will choose the lowest possible price and this choice will act as an incentive for producers to innovate to lower their cost of production, which in turn will benefit the consumer. On the other hand, when the government intervenes to set a minimum floor price, its discretion is generally open to influence by vested interests and corrupt businesses, who would indirectly use the government to defeat legitimate competition, thus defeating the very purpose of fixing a minimum price.

-Akshita Manocha
Research Associate, Centre for Justice @India Institute

The opinion statistics are based on the results of our poll – Weekly Your View- posted on our social media on 10th April,2014.