How Shortages Occur (Or the Inevitability of Scarcity)

[morgan_polotan]

I am reading The Price of Everything: A Parable of Possibility and Prosperity, by Russell Roberts, and it got me thinking about shortages and what causes them. The book is a fictional novel that introduces basic concepts of economics to the layperson in an easy to understand manner.

In the book, Ruth Leiber, an economics professor at Stanford, is describing the gas shortages that took place in the 1970′s. She describes a situation where OPEC cut back on production and the price of oil went up. To protect citizens from “price gouging”, the American government put a cap on how much gas stations could charge for gasoline. However this didn’t resolve the underlying scarcity of supply – all it did was increase demand due to the artificially lower price, and decrease supply because the price ceiling cut into the profit incentive of gas companies to find ways to supply more gas. This created shortages of gas, and consumers in the 70′s would often arrive at a gas station and see a sign that said, “Out of Gas. Come Back Tomorrow.” The professor said that the 70′s was the only period in her lifetime when you had to worry about whether the gas station actually had gas.

Contrast this situation to today. Gas prices fluctuate, and we may get upset if prices are higher than what we deem to be “fair” (even though in most cases they are simply reflecting the relative scarcity of gas), but we never worry about whether the gas station actually has gas or not. We would think it ludicrous to arrive at a gas station and have the attendant tell us, “Sorry, we’re out of gas, but if you come by sometime within the next week, we should have some.” It would probably make the news and that company would get a ton of bad press.

However shortages due to government manipulation of prices is still with us. Recently, it has come in the form of the attempt to limit “price gouging” after natural disasters. After Hurricane Katrina hit the U.S. and destroyed a bunch of gasoline refineries, a group of attorney generals imposed fines on gas stations that charged prices they deemed “excessive.” As a result, gas stations in New Orleans ran out of gas in the middle of the day and President Bush had to beg people to not buy gasoline unless they needed it. Higher prices would have achieved BUsh’s desired result of lower gasoline consumption in a more effective manner – people listen to their wallet much more than they do a man on TV (even if he happens to be the President…especially if he happens to be the President).

The same thing happened when the flu vaccine was in short supply. The same group of attorney generals threatened fines for “gouging”, so prices stayed artificially low, and lines began to form. Supply could not meet demand, and people stood in lines for six, seven even eight hours. One elderly woman even fainted, banged her head on the pavement, and died. If flu vaccine producers were allowed to respond to the increased demand for the flu vaccine, there would be temporarily higher prices, but prices would eventually fall as competitors rushed into the vaccine market to make a profit. All with no shortages.

The bottom line is that scarcity is real, and cannot be done away with just because the government wants it to disappear. So the only question should be: should we deal with scarcity by allowing the market to work, or should we let bureaucrats ration scarce resources outside of the market? Both history and common sense show that the market works far better.

What implications does this have for other parts of our economy? Health care comes to mind. In countries with single-payer health care systems (i.e. the government is the sole provider of health care), the supply of medical services (e.g. doctors, medical equipment, hospitals, etc) are rationed out by government employees. Because this process is not as efficient and responsive as a market where prices can change instantaneously, many people seeking health care end up waiting in long lines to get services. In a free market, the relative scarcity of medical services would be reflected by higher prices, not waiting lines.

Why are higher prices better than lines? Prices allow each individual to weigh the value of that good relative to other goods as well as his local circumstances, and make a decision as to whether it is worth it to buy that good at that price. Let’s take the market for prescription drugs. If there was a decreased supply or increased demand for drugs, the potential for a shortage would appear. But as long as the market had free and functioning prices, no shortage would occur because the change in prices would cause behavior changes. Some people buy the same amount of prescription drugs even if the price increased, others would cut back on their use of prescription drugs, and still others would stop buying drugs and seek out natural alternatives.

The important point is that given the inherent scarcity of the good (prescription drugs), the market provides the maximum opportunity for each individual’s preference to be met. With waiting lines, some people will benefit from the artificially reduced price, but only at the expense of others who will not be able to buy prescription drugs at all. And there is a good chance that some of those people who really need prescription drugs (heart attack victims, for example) would not be able to get drugs under a rationing process (perhaps they arrived late and waited at the back of the line) . And because it is impossible for the people doing the rationing (the government) to read people’s minds and make the best decision for everyone, lots of people will be royally screwed in the process.

Cross post