Friday, September 26, 2008

Lessons from Hurricanes

The situation created by hurricane Ike is a tragedy — and a perfect example of basic economic principles. Aggravating and dangerous shortages — particularly of ice, water, and gas — were caused by the extreme circumstances. Or were they?

If supply shortages were caused by the hurricane, how does one explain the reported shortages in Arkansas, Tennessee, and North Carolina — hundreds of miles from the Gulf Coast, and days before the hurricane arrived? It is difficult or impossible to make sense of this in light of the "extreme circumstances" theory.

Modern economics suggests that, instead, shortages are caused by overly low prices. In normal market situations, consumers will bid up the price until the total amount people are willing to buy equals the total amount available. Shortages do not happen, because people are forced by high prices to conserve. Those who don't need the resource decide it's not worth the cost, leaving those who do need it with dependable access to the supply. Prices also serve as an important signal to entrepreneurs. When prices are abnormally high, entrepreneurs see an opportunity to make easy money — and go to great lengths to deliver supplies to where they are most needed.

If the price, for whatever reason, doesn't increase in response to competition among consumers, then supplies aren't properly conserved, and sellers run out. Unresponsive prices, not hurricanes, cause shortages.

The question now, following modern economics, is "what is keeping prices too low?" Those who have been paying attention will already know the answer: anti-price gouging laws. (It just so happens that these were also in effect in Arkansas, Tennessee, and North Carolina.) These laws are made without regard to supply and demand — any company that sharply raises prices in times of crisis is liable to be prosecuted. Unfortunately, in times of crisis the price of many goods should rise sharply as a natural response to increased demand and uncertain supply. Anti-price gouging laws in this manner create de facto price ceilings.

In 1973, Richard Nixon famously instituted a price ceiling for gas. The result was easily predicted by economists — gas shortages. This high-profile case has become a staple in discussions of price controls. The result of price ceilings during emergencies is equally predictable — more shortages. The end result of gouging laws is that desperate people are forced to depend on government agencies, such as FEMA, for basic necessities, rather than a competitive, consumer-driven marketplace. If this kind of policy was legislated during normal times, there would be widespread outrage. Why, then, do we encourage it during emergencies? And what's the point of having low prices if supplies aren't available, or if you have to spend five valuable hours waiting in line to get them?

Let's imagine the situation if price gouging laws were not in place, and prices of hurricane-related goods doubled or tripled, or rose even higher. Anyone with a truck can now make a substantial profit by filling the back with gas, water, ice, food, etc., and selling it in areas where they are most needed. The incentive for owners to keep stores open and well-stocked is now increased many times over. Yes, prices are high, but supplies are readily available, available enough that FEMA is no longer needed. And as the situation stabilizes, prices will gradually sink back to their former levels, thanks to competition among sellers.

It is a serious possibility that anti-gouging laws, and the ensuing shortages, did about as much damage as the hurricane itself. At the least, they were irritating as heck.

Edit: I thought I should add a picture-

Edit #2: I originally wrote price floor when I meant price ceiling. Shame on me.

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