Hooray for Markets

There is much discussion these days about high gasoline prices and so-called "gouging" by retailers. Local news stations here report that customers have been rude to gas station attendants, blaming them for the increase in prices. Of course, it is not their fault. It is not their boss' fault either. People need to realize that whenever something we need is in short supply (and this applies to everything that we are willing to pay for), there is a need to allocate that supply to those who want it.

Pricing affects how much of the thing we want (rather than "need", like insulin or heart medicine) we are actually able to have. As prices rise, our demand for the item usually decreases. We may substitute other items that cost less, but work tolerably well for us. Or we just don't choose to consume that item at all. As prices fall, we can afford more of the item we want, and we may consume more of it or more frequently. This downward sloping demand curve thus affects our behavior.

My own family is experiencing this with gasoline prices. We live in the country, which means a drive of at least 10 miles to get to the things we need in the city, and even further than this to reach work, school, and church. What have we done? We bought a more economical car. We combine trips, even changing our schedules to make it less convenient for the purpose of saving gasoline. We might do even more of this if gasoline prices have a 3 or 4 in front of them. Of course, we have to drive some. That will cost more. We will have to cut back on other spending.

But I don't blame the nice person at the gas station, and not just because I pay at the pump. I am simply happy that I can pull into the gas station and find gas to pump. Why? Because I can count on the fact that others will do the same in response to higher prices. The price signal nudges all of us to conserve this resource, more than any sermonizing by politicans. Hopefully this will mean there is enough to go around, even with diminished refining capacity on account of the hurricane.

Other mechanisms might work, like waiting in line for gas (allocation by queing) or getting ration coupons (and creating markets for them, which ultimately will look much like higher prices). But this merely substitutes something else for price. Frankly, I like this approach for most things. Perhaps it would not be best for liver transplants or for other scarce values that involve life itself. But for stuff we want, I think it beats the alternatives.

Of course, the supply side also provides some hopeful news. We are more familiar with demand because we are always consuming, and that makes us conscious of our tradeoffs. But note this as well: the supply curve is often upward sloping for good reason. People are willing to step into the marketplace and make more of what you need as the price rises. Rising prices also spawn innovation by entrepreneurs: you can bet that in the longer run, if gasoline prices are sustained at this level there will be innovation that was previously not economical to pursue. As my pal Ralph Whitten pointed out earlier today, we might not need to subsidize ethanol production, and in fact we could find ourselves awash in energy if new technology to extract it is developed.

Of course, this can all take time. In the meantime, it can be painful to pay these prices and to make the substitutions that have to occur (such as perhaps staying in and spending less on other things that are easier to give up than our cars). However, in the long run we are likely to be better off.

So, instead of chewing out the gas station clerk, thank him or her for having what you need. And get that bicycle out of the garage.

EAM