The table below shows supply and demand for a crate of bananas at varying prices.
400,000 crates are supplied at $100 but none are sold; at $0 no units are supplied but 400,000 are demanded. In both cases there is no profit to be made, because either nobody buys or nobody sells. Under normal conditions the price would move toward $50. If the price is higher, then suppliers have too much inventory, and if the price is lower, then they are turning away potential customers.
Suppose that a politician passes legislation prohibiting suppliers from setting their own price, and decides upon a price ceiling of $25. What would then occur? A quick glance at the table above tells us that 50,000 crates will be supplied and 200,000 demanded, creating a shortage of 150,000 crates. At $25 nobody sells after 50,000 crates have been bought.
An important role of prices is to ration resources. If each buyer purchases 1 crate at $50 and 2 at $25, then when the price is $50 there are 100,000 people who buy 1 crate each, and when the price is set at $25 there are only 25,000 people who buy 2 crates each. With the price ceiling fewer people enjoy more bananas at a lower price, but at the expense of a greater number of people who must go without.
Our politician is unsatisfied. He wanted 100,000 people to buy 2 crates each, and decides to establish the Federal Banana Reserve to combat the problem. Instead of legislating the price, the he intends to increase the supply of bananas until 100,000 people can buy 2 crates each at $25. Since each buyer purchases 2 crates at $25 and only 50,000 are supplied, the FBR smust supply an additional 150,000 crates.
But the FBR is not going to grow bananas. It has magical machines that create banana apparitions. The FBR's banana apparitions look, feel, and smell like real bananas, but as soon as anyone tries to take a bite out of one, it disappears in a puff of smoke. It is these apparitions which the FBR supplies among the real bananas. At first everything runs smoothly. The banana crisis has been averted by the FBR's banana stimulus. 100,000 people can now afford twice as many bananas as before and at lower prices; the politician is reelected.
Eventually, however, people begin to try and eat their bananas. Suddenly the unwelcome discovery is made that 3/4 of the bananas bought were the FBR's apparitions. Once words gets around, demand drops like a coconut. Buyers realise that to get one crate of real bananas it is necessary to spend $100 on average! The price falls to $50 for 4 crates and only 100,000 people buy for 1 crate of real bananas.
The politician is again unsatisfied. The FBR was intended to allow 100,000 people to buy 2 crates of bananas each, and at first it was successful. But then buyers discovered that they had been fooled. Expanding the banana supply with apparitions eventually created the same problem as legislating the price did.
But a new election is coming up, and the politician desperately needs to do something about this new banana crisis. He orders to the FBR to expand the banana supply with another 350,000 crate stimulus. 100,000 people can now buy 4 crates each at $25 and receive 2 crates of real bananas. The new banana crisis has been averted. Everyone can now afford even more bananas than before and at lower prices; the politician is reelected.
Eventually, however, people begin to try and eat their bananas. Once more the unwelcome discovery is made, but this time 1/8 are apparitions. Once word gets around, buyers realise that to enjoy 1 crate of real bananas, it is necessary to buy 8 crates for $200 on average. The FBR desperately tries expanding the banana supply even more, but each time the cycle repeats the problem gets larger. Any addtitional demand which is stimulated quickly fizzles away when people discover more apparitions.
Inflation of the banana supply gets out of control. Almost every banana is an apparition, people stop buying them altogether, and even the suppliers of real bananas go out of business. In the long run, the FBR destroys the value of bananas by trying to stimulate their supply. In its wake the U.S. is turned into a banana republic.