How Administered Price Works

In most market-driven economies, rent controls and price ceilings generally characterize an administered price regime. However, free-market price discovery mechanisms also dictate administered pricing. In many centrally-planned administrations guided by Leninist philosophy (like communist Cuba and the Soviet Union), the governments usually rely on administered pricing system. Unsurprisingly, such regimes commonly reject capitalism and its free-market structures.

Most economists discredit administered pricing systems as inefficient and unsustainable. Regardless, some major capitalist market economies in both Europe and the US have embraced administered pricing. In these cases, the governments institute price control mechanisms for essential products, goods, food items, and rent. They take such actions to protect the vulnerable from the effects of artificial food shortage and lack of consumer goods.

Interestingly, when the Soviet Union first adopted administered pricing, the country had already experienced acute food shortages (this occurred in the form of bread shortage). To supplement the commodity’s demand, a thriving black market suddenly mushroomed. It’s also worth noting that during the French Revolution, the Committee of Public Safety unsuccessfully tried to limit the price of goods across the country. Similarly, in the third century, the Roman emperor Diocletian unsuccessfully tried to adopt this method, but in both cases, the prevailing market dynamics were not conducive to the success of such measures.

Example of Administered Price

In major cities (like New York), rents are usually among the highest in the country. One reason is that influential families often pass over expensive rent-controlled apartments to succeeding generations. Hence, the demand for affordable housing far outstrips the supply.

To help the vulnerable, New York City authorities often use administered pricing to effect rent control and keep housing affordable for the population. In such situations, the authorities either specify a regulated price ceiling (indicating the maximum charge) or a price floor (indicating a minimum amount) on a housing unit. Alternatively, the authorities may dictate both the price ceiling and the price floor for a given unit and impose a penalty on offenders.

Significance of Administered Price

Governments that institute administered prices often do so to maintain the affordability of essential goods and services. They aim to prevent price gouging and cushion the population from unscrupulous businesspeople who take advantage of basic commodities' shortage. For example, people who sell gasoline products often resort to hurtful price gouging at such times. In response, governments may introduce administered price control measures to stabilize essential services (like housing and rent rates) in specific areas.

In this regard, governments that introduce administered pricing may apply specific controls on basic goods like soap, oil, and sugar. They may also introduce intangible price controls on essential services (like interest rates). These administered price regimes usually change according to shifts in supply and demand, on an ad hoc basis, or by forces of design. Overall, governments institute administered pricing to protect the vulnerable.

Interestingly, administered pricing can cause an unintended shortage of goods and services. This might happen since the upward slope usually characterizes the supply curve (higher prices typically correspond to greater supply). Similarly, a downward slope characterizes the demand curve (higher prices usually correspond to lower demand). Hence, if businesses set the price lower than the market equilibrium price, the supplied quantity is less than the demand and can ultimately cause an essential goods shortage.