Price signals and behavior

For every problem there is an answer that is clear, obvious, simple, and WRONG! I’m amazed at how often people, especially politicians, find this answer.

A hurricane threatens a coast. People get in their cars to evacuate, and find that the gas stations in the area have jacked up their prices. Clearly this is greedy, unscrupulous price gouging – the gas station owners taking advantage of people’s dire circumstances to line their own pockets, right? It ought to be stopped, right? There ought to be law against it (like Florida’s), right? WRONG!!!!

Let’s think of it in economic terms. When supply is high and demand is low, prices are low. If I charge too much, there are plenty of other suppliers who will underprice me and get the business. When demand goes up or supply goes down, prices naturally rise because there are more buyers bidding for fewer items. Of course, when prices go up, signaling there is more business to be had, that encourages manufacturers to manufacture more of those items. In that way, people vote with their money about where the resources in the economy ought to be directed.

Back to the hurricane. Gas stations normally charge x dollars a gallon for gas, and get their usual stream of customers. Suddenly there are lots more customers as people head out to evacuate, but the supply is the same.

Suppose by law we keep the price the same, at x dollars per gallon. What will people do? The first people to the station will fill up their tanks with, say 450 miles worth of gas, even though they are only going 100 miles. Pretty soon the station is out of gas, and the latecomers are stranded.

Suppose we let the station raise its prices to 2x dollars per gallon. Now the first people in look at the price, find it is very expensive, and either don’t fill up if they really don’t need to, or put in only enough gas to get them away from the immediate area to a place where, they hope, gas will be cheaper (because there is a bigger supply and less demand). So the remaining supply of gas is distributed much more fairly among more people, just on the basis of the price signal.

But the gas station owners still make out like bandits, don’t they? Probably not. They make a lot more money for a day or two, and then the hurricane hits and they have to close down and new gas supplies are delayed and no one is out buying gas anyway – but of course their fixed costs (rent, wages, insurance) continue even though they don’t have any sales. So their few days of windfall profits help cover the ensuing business losses and they probably come out about even in the end.

It’s amazing to me how few people really think through the things they think are so obvious.