Economics Lesson

A hat tip to Don Luskin who passed this on from a presidential economics report. (Follow the link find the link to the full PDF report if you are so inclined).

2004 Economic Report of the President (p.155):

Market Responses to Unexpected Shortages

When there are large, unexpected increases in demand or decreases in supply for a good, a normal market response is for prices to increase by enough to restore balance between supply and demand. Consumers might accuse sellers of “price gouging” when such price increases occur in response to a natural disaster or a failure of supply infrastructure. A number of states have laws that make price gouging illegal. Even without such laws, some businesses might choose not to increase prices during an emergency for fear of a consumer backlash.

If prices do not increase, however, consumers do not receive a signal to cut their consumption and suppliers might not have the proper incentives to increase supply adequately. By not allowing market forces to restore the balance between supply and demand after the shock, nonprice rationing must be implemented instead. For example, after a pipeline break reduced the supply of gasoline into the Phoenix, Arizona, area in August 2003, press reports indicated that some stations ran out of gasoline, consumers waited in line for hours, and some drivers started following gasoline tankers as they made their deliveries.

Changes in demand can induce shortages as well. For example, in the days leading up to the arrival of Hurricane Isabel in the Mid-Atlantic states in September 2003, press reports indicated that many retailers sold out of flashlights and D batteries. The flashlights and batteries went to the first people to show up at the store, rather than to those who valued them the most. It also meant that people who were able to buy the goods might have bought more than they would have at the higher price, leaving fewer for others. Without price increases, there was no mechanism to allocate the available goods to their highest valued uses. For example, if prices were higher, early customers may have decided not to buy new batteries for their fifth flashlight and later customers would not have been forced to sit in the dark.

While allowing prices to increase in the face of a natural disaster or a supply disruption may seem unfair, the alternative would be to restrict the allocation of scarce supplies and to possibly keep supplies from those who need them most. Artificially low prices remove incentives for consumers to conserve and for suppliers to meet unfilled demand, potentially prolonging the shortage. Society must decide whether the perceived fairness resulting from regulations to hold down prices is more important than allowing the market to provide incentives for resolving the shortage as quickly as possible, while making sure that scarce resources are available for those who value them the most.

Got that, Breedo?