Price Controls Are Short-Sighted

From time to time I am asked to sign a letter espousing a particular economic policy position. I recently signed a letter urging members of congress not to impose restrictions on trade between the US and China. I've also signed on board as opposing any form of price controls, whether it is for health care, prescription drugs, or gasoline.

What follows is a letter to the editor of the Marietta Times that I wrote following the Katrina disaster.

Recent events in the Gulf Coast have shocked our economy and have led to calls for re-examining our nation’s emergency response systems. Among the calls to action is the enactment of price gouging laws, particularly as applied to gasoline. Such laws would be unnecessary at best and counterproductive at worst.

Price gouging laws reflect a basic misunderstanding of the role of prices in a market economy. Prices serve as a signal of the relative scarcity of a product. When a product like gasoline is in short supply due to, say, the disruption of production and distribution channels, then basic economics suggests that the price of gasoline will (and, indeed, should) rise. The higher price sends a signal to consumers that they should economize on their use of gasoline. Thus, consumers are encouraged to eliminate unnecessary trips, form carpools, drive more fuel efficient vehicles, and other ingenious responses. By doing so, consumers are doing their part to help allocate gasoline to those who place a higher value on the available gasoline, e.g., those engaged in the reconstruction effort in the Gulf Coast. Furthermore, a rising price will send the necessary signal to producers to expand their production in order to help alleviate the short supply.

If price is not allowed to rise to levels that equate supply and demand in the face of such disasters, then prolonged shortages are sure to follow. Is it better to have a smaller amount of gasoline available at artificially low prices or to have more gasoline available, albeit at higher prices? If the price system is not allowed to freely operate, then some other means of rationing will likely occur. For example, one would certainly expect long lines at gasoline stations to develop—reminiscent of the 1970s failed price controls on oil. How much are we willing to pay by wasting our time in such lines?

It is often argued that gasoline stations that charge extraordinarily high prices after disasters are mere profiteers, looking to make an extra buck in an unfortunate situation. If a rogue gasoline station does charge such high prices, then we are always free to shop elsewhere. If enough people react similarly, then the offending station will receive the appropriate message. Furthermore, the offending station will have to consider the harm to their reputation for their opportunistic, short run, pricing behavior.

I do not presume to second-guess the wisdom of the market as some politicians and the editors of the Marietta Times have done by calling for the application of price gouging laws. No single person (particularly any politician) has any informational advantage over the dispersed knowledge of thousands of buyers and sellers as reflected in market prices. Anybody who thinks they can “beat the market” has succumbed to what F.A. Hayek has referred to as the “fatal conceit.”