South-Western College Publishing - Economics  
If China doesn't like the market price, it just sets a new one
Subject China engages in price controls to curb inflation
Topic Equilibrium; International Trade
Key Words

price controls; shortage; supply and demand

News Story

Chinese-style capitalism takes a distinctly socialistic perspective, especially when the government thinks that market-based prices are wrong. It sets them itself.

While GDP in China has been increasing significantly over time, and the country embraces reforms to allow markets to set prices, the government repeatedly enters markets and makes adjustments when it feels that prices are too low or too high. For example, in 1998 the government in Shanghai reduced taxi fares by 30%. Other key controlled products include fertilizer, electricity, fuel and medicines.

Classic economic theory suggests that such price controls to hold down prices result in shortages. In fact, electricity was rationed last summer to create an equilibrium between demand and supply. As a result of the reduction in taxi fares, taxis have become sufficiently scarce that restaurants have resorted to hiring full-time "taxi finders" for its customers.

So why is China resorting to price controls while still trying to embrace market reforms? The government is still concerned about the rural poor, who may not be able to pay market prices for important items, like electricity and fertilizer. The poor already feel that they are being left behind in the push toward capitalism, and the government wishes to maintain some level of social stability.

(Updated October, 2004)

Questions
1.

Given the Chinese government's attempts to control prices on goods, what impact would this have on the competitiveness of imported goods? Is this likely to cause Chinese to buy domestic goods or imported goods? Why?

2. One farmer in Shanghai noted that prices on vegetables actually fell from last year, and he attributed that to basic market forces of supply and demand. What must be happening in the Chinese market for vegetables for the price to fall like that? Illustrate this with a graph of supply and demand.
3. Use a graph of supply and demand in the market for taxis in Shanghai to illustrate the effect of artificially reducing the price of taxicabs by the government.
Source James T Areddy. "China's Inflation Weapon." The Wall Street Journal, 20 August 2004, http://www.wsj.com.

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