“Similar incentives exist after a hurricane or other disaster has struck. To replenish supplies in a devastated area can cost more, due to damaged roads and highways, debris, and congested traffic from people fleeing the area. Skyrocketing local prices can overcome the reluctance to take on these local obstacles that entail additional costs. Moreover, each supplier has incentives to try to be the first to arrive on the scene, since that is when prices will be highest before additional suppliers arrive, and their competition drives prices back down.”
– Basic Economics
The Coronavirus has arrived and with it claims of price gouging by Amazon retailers and others. Fortunately, this gives us an opportunity to increase our knowledge in another economic subject, this time on price controls.
To begin our lesson, let’s assume that you pick up your newspaper or e-reader, and learn that a terrible frost has hit the state of Florida and destroyed the orange crop. In the coming weeks and months, you notice that the price of orange juice has skyrocketed. Recalling the bad weather, and its effect on oranges, you choose a “substitute good” instead, by selecting either grapefruit juice or cranberry juice. You may not have realized it at the time, but you do, in fact, understand some economics, you just didn't know it.
Next, a hurricane is predicted and ultimately lands in Texas, devastating the city of Houston. Roads and thoroughfares are damaged along with hundreds and perhaps thousands of homes and businesses. Local prices increase. Price gouging, you scream! Right? Wrong! But let’s continue.
Now, we return to the Coronavirus. We heard it was coming, so protection is needed. A mask, you think. You’ve seen the Kardashians wearing them, so it must be the right thing to do. You scroll over to Amazon and see masks are selling for over $100. Highway robbery! Right? Wrong! Next, you run to the store to buy hand sanitizer and find the shelves are bare. This is called a shortage, since nothing is available for sale at all, no matter the price. Why? Because the first people through the door have bought up the entire supply. Assuming the price had been left alone, many people probably bought up several bottles, and are storing them at home. What does this mean? It means no supply for those who were late to the party.
In case you’re still confused, let me give you one more story. A few Christmases ago, I looked for a Minnesota-themed crossword puzzle book for my mom. I hopped onto Amazon and saw that there was only one available for sale. The book was long out of print, and copies were scarce. The one book was selling for $1,500. I took a pass. The next Christmas, a handful of copies had become available, and I was able to purchase one for $15. The reason for the high price was scarcity, not a catastrophe, or greed. The high price encouraged other suppliers or individuals with the same book to hand it over, and when supplies increased, prices fell.
So, are the high prices we are seeing due to the Coronavirus a crisis of ethics? No, it’s not about ethics, it’s about economics. When a hurricane occurs, the supply chains are broken, and regular deliveries are suspended. That means the supplies on the shelf or in the storeroom are all we have until regular deliveries return. Rising prices reflect this new reality. It’s a signal to the consumer, to conserve when possible. If the price of bottled water increases, the first customers through the door will think twice about buying more than they need. If the price of bottled water had stayed the same or was lowered, the first customers through the door would buy more than they needed, leading to shortages. That is, no supply at all. Higher prices also make the arduous trek of bringing in new supplies more attractive. The same is true when there's a sudden spike in demand for goods, like masks or hand sanitizer, and supplies haven't had time to adjust, and prices rise. If you understand why the price of orange juice increases after a frost in Florida, you should understand why prices increase after a hurricane and why the price of masks is increasing after the Coronavirus scare. It’s the very same thing.
If you think it’s not important, let me tell you how misunderstanding this lesson can and has turned fatal. When price controls are enacted, requiring businesses to sell a particular product at a reduced price, it can drive the price below the actual cost of manufacturing the product. When this occurs, companies go out of business, leaving the remaining producers to pick up the slack. Unfortunately, those companies, also under the thumb of price controls, are not earning enough profit to expand their businesses. Therefore, fewer products are available for a population and shortages occur. If we are talking about food, it can and has resulted in famine and mass starvation.
If I ruled the world, every elementary school, every middle school, every high school, and every college would be required to teach a basic economics course on prices. A good place for the rest of us is Thomas Sowell’s 2015 book, “Basic Economics”. In addition to learning about prices, you will find out why the minimum wage is bad for the very people it is trying to help, how profits signal to a business that they are successfully utilizing resources and providing value to their customers, and much more. It is a lengthy tome, written for the novice who simply wants to better understand how the economy works.
So, please, the next time Mother Nature rears her ugly head, or a new catastrophe occurs, take a breath and remember today’s economic lesson.
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