NCPA - National Center for Policy Analysis

Just Wait until It's Free

July 17, 2012

Modern government is increasingly treated as a universal provider; politicians are lobbied for and subsequently provide more and more services, in the hopes that prices can be driven down to increase the number of beneficiaries. However, it remains true that there is no such thing as a free lunch: government involvement does nothing to lower prices, and almost always raises them, say Dwight R. Lee, a professor at Southern Methodist University, and J.R. Clark, a professor at the University of Tennessee at Chattanooga.

In its ill-conceived attempts to lower prices, government bureaucrats usually resort to subsidies that can offset or eliminate the cost of the good. However, in order to understand how this eventually raises prices, it is first necessary to differentiate between marginal cost and total cost.

  • The marginal cost is the amount that must be paid by the individual consumer to purchase the good after a subsidy has been applied.
  • The total cost, on the other hand, is the amount the individual must pay along with the amount paid by the government in order to subsidize its cost.
  • Individuals, as a rule, only care about the price tag they seen in front of them (the marginal cost), because they have already paid their portion of the total cost in tax monies whether they consume the good or not.
  • This leads to overconsumption as individuals are implicitly encouraged to purchase more of a good than they otherwise would.

Subsidized goods are often saddled with price controls to keep producers from responding to government largesse and increased consumer demand by raising prices. However, the price will inevitably rise, regardless of government-enforced price ceilings.

  • Because consumers pay such a small portion of the total cost in the form of the marginal cost, they are not encouraged to shop around and select the most efficient (cheapest per unit of quality) producer, allowing for significant market coverage by inefficient producers.
  • Further, because consumers often have little control over which provider they must use (e.g. public education), service providers need not supply superior service or quality goods.
  • Finally, government involvement in the procurement of public goods grows the government bureaucracy necessary for expenditure oversight, inevitably raising costs in the form of red tape.

Thus, while the total cost of the good may be taken on by other taxpayers, this should not be mistaken for the government reducing the price of a good.

Source: J. R. Clark and Dwight R. Lee, "Just Wait until It's Free," The Freeman, July/August 2012.

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