Dear Editor,
In a market economy, price is an important signal which causes consumers to compare it to their value for the commodity, and producers to their cost of production. If the price is higher than value, consumers will use less, and if higher than the cost of production, producers will decrease supply. The interactions of these two parameters, value and cost, bring about a result where the amount of the commodity demanded is exactly equal to that supplied. This is referred to as the equilibrium of demand and supply at a given price and represents the most efficient level of output.
Inflation occurs when changes take place from this equilibrium position by either an increase in demand, and/or a decrease in supply. There are consumers affected especially those with budget constraints. The political response, and it appears to be worldwide, is to intervene with measures to reduce prices or to cap them. These are the worst responses as they exacerbate shortages, as seen in Venezuela, or distorts consumers’ value system.
A preferred approach for essentials such as food and energy, is to provide support to low-income consumers who are most impacted by rising prices. In this way, only the category of consumers that need but can’t afford these necessities are assisted, instead of all categories when market prices are interfered with. All other consumers will generally respond by lowering demand and thus putting downward pressure on the price level.
The approach should be no different on the supply side. So, for example, if farmers are obtaining a lower price for their output, it is an indication that the demand and supply relationship for that output has changed, and its net supply has increased. The solution is to reduce the supply not to subsidize its production. Farmers should be encouraged to diversify away from what they are producing. But even in the US, the Government deals with these swings in farm prices with price floors, a form of subsidy. This leads to much of the food waste experienced there.
As the World moves into an inflationary period, which is expected to be around for some time, it is tempting for governments to intervene with price subsidies. Intervening in the market is never a wise move. Instead, income support should be provided to those who are affected the most by these increases but only for essentials, and everyone else allowed to express their lowered preferences given the higher prices faced.
Faithfully,
Louis Holder
