Over recent years we have been hearing a lot about Venezuela’s food shortage problem and often when problems like this occur people blame it on the wrong things simply because they do not understand fundamental basic economics. The food shortage has been a problem for more than a decade in Venezuela and many people wrongly accuse the United States sanctions for causing the problems, the reality is, the shortages are caused by government price controls by setting a price ceiling.
Price controls are destructive to the market, whenever government tries to manipulateVenezuela Food Shortage: customers left dazed and depressed from lack of supply of essential goods.prices in the market by setting price controls above or below market value, it distorts the market by creating a surplus wastage of supply or shortage of supply. In this example in relation to Venezuela’s food shortage problem I’ll be explaining about a price ceiling to help you understand. You can watch my video on this which helps explain about the food shortage here:
So what is a price ceiling and why would a price ceiling cause a shortage in supply? A price ceiling is where the government artificially lowers the price of goods or services below market value, in other words the government will artificially lower the price and set a maximum price so that the price cannot go above the price the government sets a maximum of. So why do price ceilings cause problems? As I noted in my blog post on prices they are not an obstacle for people getting what they want, rather what prices are, are signals to the market that give out valuable information to be able to allocate scarce natural resources into commodities to provide for the market efficiently. Prices can tell you:
- what resources are scarce and what is in abundance.
- where to allocate resources and where not to allocate scarce resources.
- what to produce more of and what to stop producing more of.
- what to invest more in and what to stop investing in.
In other words, prices give us valuable information about PROFITS and LOSSES in the market, so when we speak about PROFITS this tells us what consumers want more of, what to invest more in and where to allocate scarce resources efficiently; likewise anywhere there are LOSSES in the market this tells the market what to stop producing more of, where to stop putting scarce resources in the market and what to stop investing in. Too often we see a waste of scarce resources being allocated in the wrong places in the market where consumers are less in need of, whereas in other parts of the market where there is demand, there is neglect.
So what you must understand is that prices are driven by Supply and Demand in the market and when we speak about the market value, what we’re referring to is the value the consumers voted for. When consumers spend money, they are voting with their money, after all it is the consumers who dictate prices in the market, they are the ones who tell the market what they want and don’t want. Like I explained in the blog on prices it’s all well setting the price of produce YOU think is valuable, but when economic reality sets in, it’s what the consumer is WILLING to pay for produce, therefore whatever price consumers are willing to pay, that’s what market value is.
When you distort the market value via government price controls, you destroy the valuable information prices give to you, therefore you can no longer provide for the market efficiently because producers / business owners no longer know what their PROFITS and LOSSES are. To help you better understand, a perfect example of the destruction of government setting a price ceiling to artificially lower the costs of goods or services, I’ll give you my example of a company selling microphones:
Let’s imagine you were a business owner and producer of microphones and say for arguments sake a new set of microphones you have in store the government steps in and sets a price ceiling; what this basically means is the government is going to artificially drive down the selling costs of those new microphones and in relation to Supply and Demand when prices go down, demand goes up. So for this example, the governments price ceiling is going to artificially drive down costs and this will drive up consumers demand. However although this may sound nice in hindsight the problem with this is that politicians don’t look at this from a business owners perspective, why? Because in order to run a business, you need to be able to run at a profit, after all that’s the goal of business, to drive in profits to be able to produce more for company owners and workers to able to make a living. What the government fails to take into consideration are the production costs on top of the selling cost they’re going to have to sell in order to drive in profit.
So for example, if your production costs of a specific new microphone was £100 per microphone that you produce, in order to make a profit you’re going to need to sell the microphone for MORE than £100 if you sell for less than that, you’re running at a loss. So what would then happen if the government steps in, sets the price ceiling to £50 selling cost of your microphones, yet your production costs are £100 each? Simple, what the government has done, it has destroyed the incentive to produce more, what would be the point in running a business to produce microphones at £100 each but sell it for £50? There would be no point running a business and if you have no businesses, you have no money because that’s where money comes from. Government is not a wealth creator and it’s the private sector that funds the wages of the public sector. Venezuelan people queuing for hours for basic essentials.
So what the government has caused is a shortage, because you’re most certainly not going to want to produce microphones at £100 each to sell them for a maximum price of £50 each, because your business would be running at a loss and that is why Venezuela’s dictatorial government drove business and investment OUT of the country. Isn’t it funny how when you look at Chile who turned to a free market in the 1980s that investors flocked to Chile to invest in businesses? Yet where are they when it comes to Venezuela? No where, because investors only care about 2 things:
You might think that sounds greedy, but it’s not. Think of this from an investors point of view, let’s say you’re an investor, would you be willing to risk YOUR hard earned money investing in something that is going to be running at a loss where you face the risk of never seeing your money in return? Of course you wouldn’t, no sound investor would. The beautiful thing about investors is, they can help small businesses to prosperity and they can benefit from it too, so it’s not greed, it’s just a simple fact that if you’re an investor, no one in the right mind would risk lending money out to those incompetent who will waste it. That is why investors will not go anywhere near Venezuela to help businesses fund and expand their businesses because there’s no point investing in what runs at a loss.
So because government artificially lowered the cost of the produce, it has driven consumers demand up artificially and what is the major problem with this? Well what did I explain about Supply and Demand? If you stood in the middle of the Sahara Desert with a bottle of water, that is worth everything to your entire life because there is a scarcity, therefore due to the scarcity of the water and the HIGH DEMAND for water, there is a higher cost! Likewise, if you stood in the middle of Scotland filled with flowing crystal clear rivers, streams, waterfalls where there is an abundance of water, that same bottle of water is worth nothing, because you can easily pour it out and refill the bottle of water. So because there is less demand for the water in Scotland, there’s a lower cost.
So, because the government has artificially lowered the cost to a maximum price of £50 per microphone and your production costs alone are £100 each, you’re not going to produce more, so there’s going to be a SHORTAGE of those microphones and just like the water in the Sahara Desert, a shortage of those microphones means a HIGHER COST!
So essentially, although the governments price ceiling has artificially lowered the cost to £50 maximum cost, this has driven consumers demand up artificially and due to the INCREASED DEMAND whilst fewer being produced causing a shortage, that increase in consumer demand and lower supply creates inflated prices, which is the very reason why the costs of your basic essentials such as food and everything else in Venezuela has shot through the roof.
Socialism is a cancer and the sooner people learn this the better society will become.