Media Research Center


Free Market Project

Tuesday, December 20, 2005

Updated 12/06/05

Free! FMP Headlines
RSS Feed


Econ 101: The Price of Recovery
When prices rise, it helps get resources to the places theyíre needed most.¬†

By Gary Wolfram, Ph.D.
Sept. 14, 2005

Send this page to a friend! (click here)¬†¬†¬†¬† As with nearly every other major natural disaster, Hurricane Katrina resulted in short-term higher prices and cries of ďprice-gougingĒ by politicians and those who are not familiar with how the market economy works. This is a traumatic event for everyone involved, and a poor understanding of the economic forces at work only adds to the anger and confusion.

¬†¬†¬†¬† One of the key aspects of a market economy is that it efficiently sends resources where they are most valued. The press does not seem to have noticed that despite a major natural disaster that shut down a substantial portion of our county's refining capacity and damaged the Gulf Coastís offshore oil platforms, gas stations throughout the country were able to supply motorists and truckers during Labor Day weekend.

     Indeed, I drove from Hillsdale, Mich., to Chapel Hill, N.C., and back over that weekend and never had trouble finding gasoline of any grade. Less than two weeks from the hurricane making landfall, the price of gasoline is lower in Hillsdale than it was two days before the hurricane.

¬†¬†¬†¬† More than 30 statesí attorneys general are investigating the increase in gasoline prices that allowed me to drive to North Carolina and back. The U.S. Department of Energy even has a Web site that allows angry consumers to complain about the cost of gasoline. But this is all so much political posturing.

     What happened was a reduction in supply at the same time that there was increased demand for gasoline. Anyone who has had a basic course in microeconomics would be able to tell these public officials that under such circumstances the price will rise to make sure that the quantity of gasoline supplied meets the amount that people are demanding.

     Suppose the price of gasoline had not risen. Then the harm to the oil platforms would have reduced the amount of gasoline available, but there would have been no incentive for sellers to move gasoline from other parts of the country and Mexico to satisfy the increased demand caused by Labor Day traffic. Shortages would have occurred and lines would have formed at gas stations beyond the hurricane-devastated areas, and people would have been uncertain about whether they could travel at all.

     This is exactly what happened when government instituted price controls in the face of the Arab oil embargo. It is what happened regularly in the centrally planned economies of Eastern Europe in the 1980s.

     First, we might ask if it is possible for one store to charge a price that is inordinately high for any good during or after a catastrophe. Suppose, for example, Joe's Shopright begins charging $20 per gallon for milk, when the cost of producing and retailing that bottle is $2. What would happen is that the Piggly-Wiggly would underprice Joe and get his customers. Competition among sellers will keep anyone from earning a monopoly profit at the expense of the rest of the community.

     Second, it is the increase in price that gets goods to move to where they are most valued. If the price of a generator goes from $100 to $250 in Mississippi, then Hillsdale Hardware has an incentive to rent a truck and take generators down to Mississippi to satisfy the increased demand. If I were in Mississippi without power, I would rather get together with three of my neighbors to buy a $250 generator than have no generators available because no one could afford to get them to the area.

     Third, the rise in price changes the amount of a good that people will want to purchase, resulting in the good going to those who value it the most. Suppose you want some plywood to fix a hole in your roof caused by the hurricane, and I want some plywood to make a new doghouse for my dog. At $2 per sheet, I will build the doghouse, but at $4 per sheet my dog will sleep under the stars. If the price of plywood goes to $4 you will be able to get the hole in your roof covered. At $2 per sheet, I might get to the store before you and buy the last sheet. In that case you would be sleeping under the stars.

¬†¬†¬†¬† We are justifiably concerned with the effect of high prices on the poor, and no one wants to see people taking advantage of othersí misfortune. However, we would be much better off letting the price of the goods in short supply rise and then giving the poor money with which to purchase the goods. In this way the price system will be able to move goods efficiently about the country and ensure a smoothly operating economic system. This amazing system performed much better than the government in managing the supply of goods and services in the wake of the devastation caused by Katrina.

Dr. Gary L. Wolfram is the George Munson Professor of political economy at Hillsdale College in Hillsdale, Mich. He also serves as an adviser to the Free Market Project.


Send this page to a friend! (click here)