Intervening in the Market is Bad!

The fundamental theorems of welfare economics indicate that markets can be extremely effective ways of determining social production and allocating goods. It should follow that interfering with the market mechanism can be quite costly.

For example, consider price controls. Superficially, it looks like price controls -- "artificially-generated" lower prices -- benefit consumers and hurt firms. However, in a state of disequilibrium supply does not meet demand and consumers will find that they are not able to consume as much as they would like at the fixed price. This creates a rationing problem that needs to be solved in some way. Some consumers will certainly become worse off due to the restriction on trade that they face.

Or consider sales taxes. Say watches cost $6 each in a "free market." Consumers who would gain more than $6 in value from consuming an additional watch will purchase one; firms who can produce an additional watch for less than $6 will do so, and they will engage in mutually beneficial transactions. But if the government charges $1 tax on each watch sale, then a transaction will only occur if the consumer values the watch at least $1 more than its cost. So some parties lose out. Indeed, the loss to the parties is greater than the gain to the government -- this is the deadweight loss of taxation.

If we assume that all parties are identical -- a "representative consumer" or "representative firm" shall we say -- then it follows that everyone in general is hurt by price controls and sales taxes. However, if parties have sufficiently different, then it may be possible that price controls or sales taxes benefit certain parties at the expense of others. The exposition followed so far has not focused on differences.