The Theory of Black Market Prices

January 26, 1950 ECONOMIC WEEKLY The Theory Of Black Market Prices

A. K. Das Gupta

HE ESSENTIAL function of free price system is thus a deli certain circumstances lead to a T the price mechanism is the cate mechanism through which mare desirable distribution of the smooth clearance of the available are avoided all kinds of manoeuvr- available supply. supply in a market. An economic ings that would otherwise appear good is a good whose supply is in society as a result of the pres There is, however, one aspect of scarce in relation to demand,— sure of demand upon scarce the matter which must not be lost Scarcity' implying simply that supply. sight of. The limitation of the the entire want of the society is free price system that we have not satisfied by the available sup Yet there is just one limitation mentioned-arises out of large in ply. In view of the scarcity of of the free price system, however equalities of income. It is be supply, buyers press against one satisfactory it might be in respect cause of this inequality that the another, and those who fail to of the smooth delivery of goods. normal price fails to satisfy the offer the ruling price in the mar The system caters to the wants of general need of the society to the ket go unsatisfied. Price thus stronger members of the society extent deemed desirable. Now, if measures the strength of excluded at the expense of its weaker mem this problem of inequality can be demand,—being determined by bers. And since this strength ex tackled directly, through taxes the degree of scarcity of supply presses itself, partly at any rate, and subsidies, or through other relatively to the market demand. in terms of the capacity to pay, measures of general income con In a free price system, excess de the distribution of a good, as it trol, the case for price control mand or excess supply are ruled takes place through the market surely disappears. If the income out. Excess demand is a signal mechanism, turns out to be in ratio between different groups in for a price rise, and excess supply accordance with the relative the society is brought down to is a signal for a price fall. Com 'income' of the citizens rather than the level that is considered desir petition among buyers and sellers in accordance with their relative able, the free price system surely brings it about that a price is set needs. And in a society which is comes into its own. In principle, tled in the market at which de characterised by large inequali indeed, this is a surer way of mand is equated to the supply. ties of income, this limitation achieving the objective that we The available supply is taken off proves a serious limitation. have in view. Whereas an over the market by those buyers who all income control relieves the are relatively stronger and are This is the sanction for price State of the necessity of looking prepared to offer the ruling price; control. If the normal price is into individual markets, the prin those who cannot afford to pay found too high for the poorer ciple of price control, since it re the ruling price go unsatisfied. section of the community and if lates to individual markets, re The strength of the buyers as ex it is felt that they should also be quires a wider and a more ex pressed in the market depends allowed to have a share of the tended supervision, its nature de not merely upon the degree of available supply of a commodity, pending upon the character of the willingness to have a good, but the State comes forward and fixes market and the number of com also upon the capacity to pay for a legal maximum for the market modities to be controlled. it. price. A price below 'normal' is fixed and sellers are coerced into What happens if the price of a The price at which demand is accepting what is deemed to be commodity is fixed by the State at equated to the supply is called by the maximum allowable, consist a level below what it would be economists the normal price. In ently with the demand coming under the free play of the forces a free market, demand and supply from the relatively poor.* A price of demand and supply? A state of forces can be relied on to secure fixed below normal does bring the 'excess demand' is created; sellers the establishment of a normal controlled good within the reach offer to sell a quantity which price and to ensure the smooth of the hitherto unsatisfied buyers, falls short of that which the buy disposal of a commodity. Each although in doing so, it deprives ers are willing to buy at the given has the right to bid his own price the stronger buyers of a share price. The market thus expe for the commodity that he wants, that would, in the absence of riences 'shortage' which is to be and if the price offered satisfies control, belong to them. If the distinguished from 'scarcity' pros the seller, the deal is finished with control is judiciously and effec per. For, whereas 'scarcity' de out more ado. On the other hand, tively administered, it may under notes merely that some demand is however intense the need that he excluded because the buyers can may feel for a commodity, it re * The opposite case,—that of not afford to pay the ruling price, mains unsatisfied unless it is back fixing a minimum price,—is not 'shortage' indicates that even ed by the power -to pay a price relevant to our present problem those buyers who are willing to which will satisfy the seller. The and is therefore ruled out. pay a price acceptable to the

97 January 26, 1950 ECONOMIC WEEKLY The Theory Of Black Market Prices A. K. Das Gupta

'HE ESSENTIAL function of free price system is thus a deli certain circumstances lead to a T the price mechanism is the cate mechanism through which more desirable distribution of the smooth clearance of the available are avoided all kinds of manoeuvr- available supply. supply in a market. An economic ings that would otherwise appear good is a good whose supply is in society as a result of the pres There is, however, one aspect of scarce in relation to demand,— sure of demand upon scarce the matter which must not be lost 'scarcity' implying simply that supply. sight of. The limitation of the the entire want of the society is free price system that we have not satisfied by the available sup Yet there is just one limitation mentioned-arises out of large in ply. In view of the scarcity of of the free price system, however equalities of income. It is be supply, buyers press against one satisfactory it might be in respect cause of this inequality that the another, and those who fail to of the smooth delivery of goods. normal price fails to satisfy the offer the ruling price in the mar The system caters to the wants of general need of the society to the ket go unsatisfied. Price thus stronger members of the society extent deemed desirable. Now, if measures the strength of excluded at the expense of its weaker mem this problem of inequality can be demand, -being determined by bers. And since this strength ex tackled directly, through taxes the degree of scarcity of supply presses itself, partly at any rate, and subsidies, or through other relatively to the market demand. in terms of the capacity to pay, measures of general income con In a free price system, excess de the distribution of a good, as it trol, the case for price control mand or excess supply are ruled takes place through the market surely disappears. If the income out. Excess demand is a signal mechanism, turns out to be in ratio between different groups in for a price rise, and excess supply accordance with the relative the society is brought down to is a signal for a price fall. Com 'income' of the citizens rather than the level that is considered desir petition among buyers and sellers in accordance with their relative able, the free price system surely brings it about that a price is set needs. And in a society which is comes into its own. In principle, tled in the market at which de characterised by large inequali indeed, this is a surer way of mand is equated to the supply. ties of income, this limitation achieving the objective that we The available supply is taken off proves a serious limitation. have in view. Whereas an over the market by those buyers who all income control relieves the are relatively stronger and are This is the sanction for price State of the necessity of looking prepared to offer the ruling price; control. If the normal price is into individual markets, the prin those who cannot afford to pay found too high for the poorer ciple of price control, since it re the ruling price go unsatisfied. section of the community and if lates to individual markets, re The strength of the buyers as ex it is felt that they should also be quires a wider and a more ex pressed in the market depends allowed to have a share of the tended supervision, its nature de not merely upon the degree of available supply of a commodity, pending upon the character of the willingness to have a good, but the State comes forward and fixes market and the number of com also upon the capacity to pay for a legal maximum for the market modities to be controlled. it price. A price below 'normal' is fixed and sellers are coerced into What happens if the price of a The price at which demand is accepting what is deemed to be commodity is fixed by the State at equated to the supply is called by the maximum allowable, consist a level below what it would be economists the normal price. In ently with the demand coming under the free play of the forces a free market, demand and supply from the relatively poor.* A price of demand and supply? A state of forces can be relied on to secure fixed below normal does bring the 'excess demand' is created; sellers the establishment of a normal controlled good within the reach offer to sell a quantity which price and to ensure the smooth of the hitherto unsatisfied buyers, falls short of that which the lay disposal of a commodity. Each although in doing so, it deprives ers are willing to buy at the given has the right to bid his own price the stronger buyers of a share price. The market thus expe for the commodity that he wants, that would, in the absence of riences 'shortage' which is to be and if the price offered satisfies control, belong to them. If the distinguished from 'scarcity' pros the seller, the deal is finished with control is judiciously and effec per. For, whereas 'scarcity' de out more ado. On the other hand, tively administered, it may under notes merely that some demand is however intense the need that he excluded because the buyers can may feel for a commodity, It re * The opposite case,—that of not afford to pay the ruling price, mains unsatisfied unless it is back fixing a minimum price,—is not 'shortage' indicates that even ed by the power -to pay a price relevant to our present problem those buyers who are wilting to which will satisfy the seller, The and is therefore ruled out. pay a price acceptable to the

97 ECONOMIC WEEKLY January 26, 1950 sellers may have to go unsatis lower than the normal price as it not have access, Kenneth E. fied. Scarcity is ubiquitous in the would be in a free market? What Boulding's Economic Analysis exchange economy; the fact that tends to be the output of a commo contains an ingenious theory of a price is to be paid at all is an dity that finds its way into black black market prices, although indication that scarcity exists. markets? Does it exceed, or fall even here, as the present paper Shortage, on the other hand, is the short of the normal output? This purports to show, the matter has outcome of an artificial control is a new field of enquiry which been presented in too simpliste a which puts a brake on supply but has opened up in the wake of war fashion and the essential character at the same time releases a de and post-war price controls and of the phenomenon has been lost mand which otherwise would re rationing. For, since these con sight of. main subdued. trols have been introduced, black markets have been a common The following diagram is the How is this short supply dis phenomenon almost everywhere. basis of Boulding's analysis.1 tributed among the intending buyers? Does it go to those who Not enough has yet been done, D and S represent the normal come first, or to those who are it appears, by our economists to demand and supply curves as they physically stronger and can push analyse the affairs of the black would be in the absence of con others out of the market? Obvi markets. We have had a lot of trol. PN would then be the nor ously any such processes would discussion concerning the difficul mal price, and ON the amount frustrate the object of price con ties arising from the hetero bought and sold. If, now, OR is trol The technique of rationing geneity of products within the fixed by the State to be the maxi is thus the essential corollary of same industry, differences in the mum price at which buying and a system of price control. The costs of different firms, vague selling are legally allowed, the controlling authority undertakes ness of the needs of consumers, quantity supplied comes down to to arrange a distribution of what etc. We have also been told about RT and the quantity demanded ever supply is available at the the possible failure of price con goes up to RV. To relieve the legal price among the intending trol measures in view of the illegal congestion of demand, the com buyers according to their relative transactions that 'shortages' would modity is rationed. But since the needs. This obviously means inevitably call forth. But the available supply in the legal mar-r that, although people 'at the bot actual operations of the black ket is only RT, many willing tom of the scale' get a part of their markets, inspite of their wide pre buyers go unsatisfied, and an demand satisfied, those at the valence, have been left practically illegal market develops. What upper end of the scale are asked alone. But not entirely. Apart are the demand and supply con to accept a ration smaller than from a few Journal articles to ditions in this illegal market? what, with their stronger pur which the present writer could Here is Boulding's own story: chasing power, they could secure in a free market by bidding up prices. Here, therefore, are buy ers eager to pay higher prices for an extra supply and sellers equally eager to switch on to the stronger market if only such a market can be created. Thus the emergence of the so-called 'black market' is the inevitable conse quence of price control and rationing. Because there are buy ers prepared to buy at higher prices more than their ration coupons allow, and because there are sellers to whom the commer cial code rather than the law of the land is supreme, and who are therefore anxious to sell their good to the highest bidder, an area tends inevitably to develop over which transactions take place at prices higher than the legal maximum,—its extent de pending upon the degree of super vision exercised by the state towards the enforcement of law. How are black market prices determined" Do they tend to be January 26, 1950 ECONOMIC WEEKLY

"We can postulate a 'black market the resulting average price is less black market. If the marginal supply curve', TSB lying to the than that which would have risk-cost remains constant; the1 left of the normal supply curve obtained in a perfectly free mar two curves will be parallel. If, on TS. As operations in the black ket." And thirdly, the more the other hand, as is more likely, market involve a certain risk rigorous are the measures taken the sellers are afraid that exten above what would be necessary against the black market buyers sion of sales in the black market in a free market, suppliers are the lower is the black market will involve wider pubicity and not to be found willing to supply price, and the larger the penalties increasing risk of detection, the as much at each price in the black placed on sellers, the higher is the distance between the two curves market as would be done in the black market price,—the inference will grow wider as they move to free market; in other words, be from this being that "other things the right. In any case, the initial cause of the higher costs it now being equal, it would be better to point on the black market supply takes a higher price to call forth penalize the buyers rather than curve will be vertically above T. any given quantity than it did the sellers in the black market, Further, the amount sold in the before. The higher the costs of the housewife rather than the legal market will depend not only black market operation, the grocer.'' upon average cost, as is assumed steeper will TSB rise. We can in the diagram, but also upon the similarly postulate a black market While the above analysis raises degree of restriction that is placed demand curve, T'Db. Even at the certain interesting issues, the upon black market selling. RT is legal maximum price (OR) we manner in which the problem is certainly the maximum amount may suppose that not all potential handled leaves room for further that can be sold at the controlled buyers are willing to buy in the reflection. In general, the exten price, OR. Yet it may not be the black market, so that the quan sion of demand and supply curves, actual amount released in the tity demanded in the black mar such as is done, to cover the black open market at that price, since ket at the price OR is not the total market area is not only logically the black markets would promise unsatisfied demand quantity, TV. untenable but is also misleading a higher return. To what extent but a smaller quantity TDb .... in its implications. To an exami output which could profitably be Then the black market price is nation of this we shall now turn. sold in the legal market would P1,N1 and the quantity bought and nevertheless disappear into the sold in the black market is TK, In the first place, it is wrong to dark area will depend upon the RK being the total quantity in the take the unobstructed black mar rigour with which black market legal and the black market com ket demand curve to be just an dealings are treated, bined, and RT the quantity in the extension of the original D— legal market." It is further curve. It must be remembered Thirdly,—and this is by far the argued that in case "there are no that, according to hypothesis, the most important point about the penalties of any kind, legal or legal supply, RT, is sold at the whole matter,—the so-called moral, attached to purchases in controlled price, OR, and is thus black market is a bundle of iso the black market, the black mar open to buyers within the range lated transactions which, strictly ket demand curve will be the PV equally with the buyers be speaking, do not form a market same as the normal demand longing to the upper range. If, at all. The illegal character of the curve, DP2, so that, with TSB then, a part of the amount sold in transactions naturally precludes as the black market supply curve, the legal market is taken away by the possibility of that degree of the black market price will be as buyers lying below the range RT, inter-communication between high as P2N2. On the other hand, the demand curve in the black buyers and sellers which makes if suppliers are unmolested and market, in the absence of penal for a perfect market with a uni penalties are placed only on ties, gets shifted above DP2. The form price. By its very nature, black market buyers, the black stronger buyers within the range the black market, such as it is, is market price will be as low as RT, with part of their demand un at best an imperfect institution in satisfied, assert themselves in the which individual buyers and black market and offer a price sellers are, so to say, paired, and Boulding derives the following which is higher than is shown in separate prices tend to evolve in conclusions from his analysis of the original demand curve. Neg respect of the same commodity, the black market: lecting obstacles to demand, there —the level in each case depending fore, the point T1 invariably lies upon the relative strength of -the First, the black market price vertically above the D—curve. parties. To talk of the black mar- may be less than the normal price ket price, determined at the point as it would be in a free market; As regards the black market of intersection between the black P1N1, as the diagram shows, is supply curve, if risks attend black market demand and supply less than PN. Secondly, the aver market selling, this curve should curves, is thus illegitimate. Indeed age price in the legal and the lie above the S—curve over its the theory that is relevant here is black market together is likely to whole length, the distance bet rather that of imperfect market be less than the normal price, so ween the two curves depending and discrimination, and the tech that "even if a black market deve upon the marginal risk-cost asso nique that is appropriate is that lops as a result of price control ciated with increasing sales in the of marginal revenue and marginal

99 ECONOMIC WEEKLY January 26, 1950 cost, The intersection between combined area, when account is equalities are called for as a spe 'the black market demand and taken of its repercussion on the cial incentive measure, as in times supply curves may point to a volume of output available for the of war,—the proper remedy for minimum price at which a parcel 'open' area, these excesses is tax-cum-subsidy of product might be sold profit rather than price control and ably, due account being taken of Thirdly, since, if the law is to rationing? The verdict of Profes the risks of such sales; it does not be taken at all seriously, the sor, Bobbins on this matter is well indicate the average price at objective of policy must be to stop worth pondering over: "If it which the black market output black market dealings, or, at any is felt that the working of is actually sold. Thus even if rate, to reduce their area to the the market results in a dis the black market supply curve minimum, it is a matter of in tribution of goods which is cuts the black market demand difference whether buyers or not equitable, the remedy is to curve at P1 (as shown in the dia sellers or both are chosen for be found, not in suspending the gram), the amount bought and punishment in respect of these market or in falsifying the system sold in the area will not be neces dealings. For it is just a question of prices, but rather in direct ope sarily ON1 nor will the average of keeping the demand curve ration on the level of net incomes price be necessarily P1N1. Since below the supply curve in the and property either by way of some degree of discrimination will black market region. And this of taxation or by way of subsidies to be possible, the average revenue course can be done either by persons. If it is thought that the curve will surely lie above T'Db. pushing down the demand curve rich get too much, then they through penalties on buyers or by should be taxed. If it is thought What does all this lead to? How pushing up the supply curve that the prices of essential com are our generalisations concerning through penalties on sellers. modities are too high for the poc black markets affected by these Either of these operations, if kets of the lowest group of income considerations? carried on successfully, would receivers, then give them money. serve the purpose equally well Or if it is felt that the poorest In the first place, since the black It is for the State to decide which consumers are so silly or so irres market area is dominated by would be more convenient and ponsible that they cannot spend stronger buyers and since, in the more effective from the adminis increased money incomes properly absence of inter-communication, trative point of view. either for themselves or (what is sellers, strengthened by the fact more important) for their child of shortage, are in a position to Lastly,—given the black market ren, then give them income in apply discrimination to their supply curve, the higher the kind. But do not throw the baby advantage, the average of prices penalties placed on illegal buying out with the bath water by sus within the black market area the lower surely is the average of pending the market or by fixing (which, according to our hypothe prices, but the smaller also is the prices below the market equili sis, exceeds the marginal demand output sold in the black market. brium. That way lies frustration price) tends to be higher than the If, then, consumers' surplus is and much economic waste."* normal price as it would be in a taken to be the criterion of gain to free market. The reverse may buyers—to estimate which penal * Lionol Robbins, The Economic happen only if very high penalties ties, both actual and potential, as are placed upon black market Problem in Peace and War (Mac- also the loss of output available. millan, 1947), pp. 8-9. buyers. are to be taken into account,—it is misleading, under the pretext of Secondly, the average price in price reduction, to make a scape the legal and the black markets goat of the buyer. taken together, depending, as it does, upon the level of controlled These considerations ' suggest price, the level of black market the sort of dilemma to which a prices and the area covered by policy of price control and ration illegal transactions relatively to ing gives rise. If control over the the open market, may easily ex black market is slackened, aggre ceed the normal free market gate output expands, but the legal prise. This tendency becomes all market is left high and dry, and the more likely if control over the scheme of rationing is endan black market dealings is slacken gered. On the other hand, if con ed, for, in that case, a larger pro trol over the black market is portion of the aggregate output tightened, the supply in the legal goes into the black market area. market expands, but the aggre Thus an act of concession to black gate output shrinks, and there is market sellers, while it may bring damage to consumers' surplus. down black market prices as such, is altogether not certain in its Does it not follow, therefore, effect on average price in the that,—except where large in

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