Gouging or Economizing?

When disasters strike, normal supply chains are cut. Store shelves will not be restocked for a while. The current stock of gas, food, and supplies may be the last the store will see in perhaps a long time.

In other words, there are fewer things people can purchase. Everyone's a loser here: the consumer and the seller. Yes, if one store is unharmed while competitors are destroyed by the storm, it will get all the business. But if it doesn't raise prices, there will be a run on the store as consumers will stock up on everything, and the shelves will soon be empty with no restocking for a while.

Natural disasters result in a loss of goods and services for the consumer, and the loss of business for the seller.

Some - actually, many - say that the seller must bear all the cost when disasters strike. He must sell everything at the same price as before, as if there was no shortage of supplies. When his inventory is completely sold, he then can not sell anything at all until the supply chain is restored, and then he must pay to restock the entire store all at once.

When natural disasters cause shortages, everyone's economic behavior must change. Not just sellers, but consumers. Sacrifice is inevitable; luxuries must be dispensed with. Necessities, such as a bottle of water, now needs to be shared between two people, when previously they each enjoyed their own. Medicine may have to be taken at longer intervals than before. Don't blame the economy, blame the storm.

Prices reflect this. Thirteen months ago, after hurricane Charlie, David Brown wrote:

Well, let's consider ice. Before Charley hit, few in central Florida had stocked up on ice. It had looked like the storm was going to skirt our part of the state; on the day of landfall, however, it veered eastward, thwarting all the meteorological predictions. After Charley cut his swath through central Florida, hundreds of thousands of central Florida residents were unexpectedly deprived of electrical power and therefore of refrigeration. Hence the huge increase in demand for ice.

Let us postulate that a small Orlando drug store has ten bags of ice in stock that, prior to the storm, it had been selling for $4.39 a bag. Of this stock it could normally expect to sell one or two bags a day. In the wake of Hurricane Charley, however, ten local residents show up at the store over the course of a day to buy ice. Most want to buy more than one bag.

So what happens? If the price is kept at $4.39 a bag because the drugstore owner fears the wrath of State Attorney General Charlie Crist and the finger wagging of local news anchors, the first five people who want to buy ice might obtain the entire stock. The first person buys one bag, the second person buys four bags, the third buys two bags, the fourth buys two bags, and the fifth buys one bag. The last five people get no ice. Yet one or more of the last five applicants may need the ice more desperately than any of the first five.

But suppose the store owner is operating in an unhampered market. Realizing that many more people than usual will now demand ice, and also realizing that with supply lines temporarily severed it will be difficult or impossible to bring in new supplies of ice for at least several days, he resorts to the expedient of raising the price to, say, $15.39 a bag.

Now customers will act more economically with respect to the available supply. Now, the person who has $60 in his wallet, and who had been willing to pay $17 to buy four bags of ice, may be willing to pay for only one or two bags of ice (because he needs the balance of his ready cash for other immediate needs). Some of the persons seeking ice may decide that they have a large enough reserve of canned food in their homes that they don't need to worry about preserving the one pound of ground beef in their freezer. They may forgo the purchase of ice altogether, even if they can "afford" it in the sense that they have twenty-dollar bills in their wallets. Meanwhile, the stragglers who in the first scenario lacked any opportunity to purchase ice will now be able to.

The principle applies to all products, and in circumstances more dire than Orlando's last year. High prices help people acquire what they need most. It does so by giving them the incentive to give up what they don't need as much, but which someone else may desparately need.

The principle also holds in less catastrophic circumstnaces,such as the nationwide gas price hikes after Hurricane Katrina. Brad at McBlog writes:

My father's old car was sitting idle, waiting to be sold. He drove my stepmother's old car about 2 miles a day; she drove her new minivan about 40 miles a day, and my stepsister drove her new monster SUV about 60 miles a day. Then Katrina hit.

My stepsister (with the longest commute) now drives my father's old car. My stepmother (second-longest) drives her old car. My father (shortest commute) drives the minivan. And the SUV sits idle. I'd hazard a guess that they've cut their combined gasoline consumption by 40%.

This is how the free market promotes conservation.