A consequence of low fixed prices
When the government sets maximum prices, an underground market (sometimes referred to as a black market) is likely to result. An underground market is one where sellers ignore the government’s price restrictions. But why is it in their interest to do so, given that they probably run the risk of fines or even imprisonment?
Take the case of wartime price controls. The government set maximum prices for many essential items that were in short supply. This is illustrated in the diagram.
The unacceptably high equilibrium price is P e. The price fixed by the government is P g. But at P g there is a shortage of Q d – Q s. To deal with the shortage, either the government will have to accept queues, or shops selling only to ‘regular’ customers; or alternatively a system of rationing will have to be introduced. But whichever system is adopted, one thing is clear: many consumers would be prepared to pay a price considerably above P g in order to get hold of the good. The demand curve shows this: the less the supply, the higher up the demand curve will the equilibrium price be. This is where underground marketeers come in. Provided they can get supplies (maybe by some shady dealing), provided they can have access to consumers, provided consumers are willing to break the law, and provided they can escape detection, underground marketeers can charge a price considerably above P g. But what price can they charge? Take the extreme case. Assume that the underground marketeers buy up all the supply (Q s) from the producers at the official price and then sell it at a price that clears the market. The underground-market price will be P b: at that price, demand is equal to Q s. The underground marketeers gain the extra revenue shown by the shaded area. In practice, of course, many people will get their supplies from official sources, and pay only P g. On the other hand, if underground marketeers are few in number and have only limited supplies, they could sell them at very high prices: above P b even. During the Second World War, ‘spivs’ (as these underground marketeers were called) could often charge extortionately high prices for such items as nylon stockings and coffee.
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