Tuesday, July 8, 2008

Good Ole Price Controls!

Students love real-world examples, and while they are hard to find for some economics topics, they certainly are not for price controls. Oil in the 70's, rent control in New York, the minimum wage: price controls are one of the easiest concepts to teach because examples abound.

While examples do abound, the more recent the example the better. Today NPR ran a story titled "Credit Crisis Shakes Confidence in Student Loans." To help students the government reduced the rate lenders can charge on student loans. Yet this will not help students if it causes those lenders to withdraw funds for loans -- which is exactly what they did.

Besides teaching that price ceilings produce a shortage, we should emphasize to students that while government can control prices, they cannot control costs. We should also point out that reducing the profits of a seller does not always make the buyer better off. Life is not a zero-sum game, and neither is lending. Either both parties benefit or neither.

The article can be found at http://www.npr.org/templates/story/story.php?storyId=92308792, containing both text and audio. The most relevant part of the story is shown below. Enjoy!

Wadsworth says the problems actually began last September, when Congress passed the College Cost Reduction and Access Act. It made more financial aid available to the neediest students and lowered the interest rates for new borrowers.

It paid for all this by cutting the interest that banks and private lenders earn on every student loan they make. Wadsworth says it also doubled the fees that lenders pay the federal government for every loan they issue.

"It became less profitable — or in some cases unprofitable — for lenders to lend money," he says.

Lawmakers defended the act, arguing that they were more concerned about students than lenders' profits. Then the subprime mortgage crisis hit.

"The financial markets went into turmoil and that had a spillover effect into student loans," Wadsworth says.

By the end of 2007, he says, lenders could not raise the money to make new loans. And those that could quickly realized that the costs of making those loans had gone up dramatically. So some lenders stopped making loans.