Administered Price

What Is Administered Price?

An administered price is the price of a good or service as dictated by a government or centralized authority, as opposed to buyers and sellers interacting according to supply and demand.

Understanding Administered Price

Administered pricing has appeared in communist regimes such as the Soviet Union, and is discredited by many economists as being inefficient and unsustainable. In otherwise generally market-based economies, certain administered prices may be imposed such as in the form of price ceilings, rent controls, or minimum wages.

Administered prices occur in two general contexts.

1. First in the context of a centrally planned economy, the central planner requires some method of assigning values to goods, services, and factors of production in order to account for costs and decide among possible production plans. Lacking market prices, the central planner assigns administered prices to goods and productive factors, either implicitly or explicitly.
2. Second, in a mixed or mostly-capitalist economy, rulers and policy makers may decide to interfere with market prices in order to achieve a given policy goal, such as to raise wages for workers or to discriminate for or against certain groups in society. Or, they may believe that they have to assign administered prices in place of market prices for certain goods that pure market forces may be unable to price efficiently, if at all.

Most economists believe that whether, and the extent to which, a given good should be priced administratively or by markets depends on how accurately a market can price that good. For the most part this means how well market conditions for that good reflect the ideal conditions given by the assumptions of perfect competition in economic models. Where these conditions apply, mainstream economics teaches that allowing buyers and sellers to freely negotiate the price of the good is the most efficient method of pricing.

For goods that can be accurately priced by markets, this means that imposing administered prices always results in a net loss of social welfare for the society. For example, classical economic theory shows why price controls tend to lead to shortages in this situation. The supply curve has an upward slope, meaning the higher prices correspond to greater supply; the demand curve has a downward slope, so higher prices correspond to lower demand. If a price is set lower than the market equilibrium price – the point at which the two curves intersect – the quantity supplied will be less than the quantity demanded: in other words, there will be a shortage, which makes both buyers and sellers worse off relative to letting the market clear.

But the less the conditions of perfect competition apply to a given good, the less efficiently a market for that good is thought to function. This is known as market failure. This can take many forms such as partial market failures, or market imperfections, like natural monopoly, monopsony, or externalities, or complete market failures like public goods or common-pool resources. Market failure opens up a possible role for government to fix the market and improve the economic efficiency of production, allocation, and distribution of goods in the economy relative to a pure free market.

However, any proposed improvement on economic efficiency gained through imposing an administered price should be weighed against the inevitability of costs and inefficiencies imposed by the administrative process itself.

Administered prices are set by some process, be it democratic, technocratic, or dictatorial, all of which have their own costs and problems. These include information problems, where the absence of market prices for various goods leaves the government essentially guessing what price to administratively set for a given good, and incentive problems such as rent seeking behavior, where self-interested parties seek to influence the level of the administered price in their own favor.

These problems mean that the government administrators might not be able to correctly administer prices any better than the imperfect markets that they seek to regulate. In many cases, cost associated with these problems may outweigh the prospective gains from correcting a market imperfection or market failure.

Examples of Administered Prices

Centrally planned economic systems such as communist Soviet Union and Cuba employed administered prices extensively (Cuba continues to do so). In both of these examples, the market for food and consumer goods was characterized by chronic shortages. Bread lines were a fact of life in the Soviet Union, and a thriving black market existed to supplement unmet demand. Other attempts at limiting prices across an economy, for example by the Committee of Public Safety during the French Revolution and the Roman Emperor Diocletian in the third century, have been largely unsuccessful.

Mixed and mostly-capitalist economies do not entirely shun administered prices either. Examples of administered prices include price controls and rent controls. Price controls are often imposed to maintain the affordability of certain goods and to prevent price gouging (of gasoline, for example). Rent control and stabilization are used to limit rent rises in certain cities.

Rent control is used to keep housing stock affordable in New York City, but the demand for these cheap apartments far outstrips the supply. Since market-rate rents are among the highest in the country, rent-controlled apartments in the city are often passed down within families as a coveted good.

Price controls may specify a price ceiling (a maximum), a price floor (a minimum), or both. They may apply to staple goods such as sugar and soap, or to more intangible prices such as interest rates. They may change in response to shifts in supply and demand, either by design or on an ad hoc basis.