You have two groups:
Group A is limited to in state only and pays at rate Y.
Group B is limited to out of state only and pays at rate 2Y.
Group A is restricted from participating in Group B's pay plan and vice-versa.
The number of participants in each group is fixed and being restricted by artificial means (government control).
Your comment regarding free market forces would be correct only if Group A was given the option of participating at the rate paid by group B.
When one controls market forces by government fiat, "free market rules" are no longer applicable.
My comment was that market forces are being applied to Group B. On the path to free markets. They are restricting sales to group A because they do not pay production costs.