Sorry for the long pause since last post! Birth of granddaughter, the holidays, Covid, etc. Such is life, right? Came across this article and at first glance, thought to pass it up; however, upon reading, it's a textbook example of microeconomics in action. Seemingly good ideas, like anti-price gouging laws and the like, are actually terrible economic policy.
Microeconomics is rooted in the elegant model of supply and demand. The "invisible hand" of price does an amazing job at balancing the needs of both buyers and sellers. When the government, or anyone for that matter, starts interfering with the free market allocation of scarce resources, strange results can arise. Consider the case of PPE. Once masks were shown to be an effective defense against the virus, what do you suppose happened to the "demand" for masks and PPE? Surprisingly, some aspects of economics are quite intuitive. If you said "demand will soar," you'd be entirely correct. But how do we model "demand soaring?" I always found that my economics students were very adept at understanding the consumer (demand) side of the model; however, the supply side, not so much. So, let's consider the supplier of masks/PPE. With our entire economy operating under the "just in time" inventory model, most PPE suppliers were already operating at near capacity. What would incentivise a PPE supplier at this point to produce more PPE? I have repeatedly told my students over the years that you can't hold a gun to the head of a supplier and tell him to produce more (this only happens in socialist economies!). The supplier has to willingly want to supply more, and usually they can be incentivized with the prospects of higher profits. Within the context of our demand and supply model, the following events occur. Pre-Covid, let's assume that the price of an N95 mask was $1. Why $1? Because $1 is the magical price which balanced the supply and demand for masks prior to Covid (P1 in the graph below). In economics, we call this the equilibrium price. It is the price where the demand curve intersects the supply curve and all the masks which are produced are then sold! Back to Covid: the demand for N95 masks soars right? This is illustrated with a rightward shift of the Demand curve (increases are always to the right in supply and demand, and decreases are always to the left). This shift is seen by the "New Demand" curve illustrated below. Notice, I said nothing about the supply curve changing at this point. The supply curve is unchanged at this point in time, the only thing occurring is that suppliers phones are ringing off the hook. The old price of $1 per mask is no longer an equilibrium. Why? Because the guy producing masks now has more people wanting masks than he can produce. What if the price of masks started to rise? Would this incentivize suppliers to produce more? You bet! They would bring on more labor to work round the clock, etc. but only if there's additional money (profit) to be made. It's not cheap to ramp up production, and as production increases, so does the additional cost (marginal cost) of each mask. As the price starts to rise from $1 to P2, suppliers produce more masks, calls quiet down and equilibrium is restored. Right? Wait a minute, what if P2 is $10/mask? The supply & demand model tells us the direction of change (e.g. the price of masks will rise), not the magnitude of the change (the price of masks will rise to $10). It is entirely possible that the new equilibrium price could reach $10/mask. We also have to remember that this is a short term problem. Over the long haul, as Covid became entrenched, suppliers built new facilities (which would shift the supply curve to the right, but that's for another story); however, in the short run, that is not possible. The graph below illustrates a perfectly free market for N95 masks, but what if someone (usually the government) thinks that the new equilibrium of $10/mask is too high? What if, dare I say it, Google also thinks this price is too high? That is exactly what happened! The price rising too high/too fast hit thresholds for "price gouging."
These sound like well meaning laws/rules don't you think? We don't want anyone to be taken advantage of, right? As an aside, in today's high tech, information overload, how is it possible to gouge anyone? If you don't like the price, just use and "App" to find it cheaper. Does "big brother" really need to get involved here? Sorry, just ranting. The law is the law, and Google rules are Google rules, and they actually kicked in with the mask/PPE market. So what happens when the government, or Google, or anyone sets a "price ceiling" for a product? A price ceiling means just that: the price of N95 masks is not allowed to go above $5/mask, or else you face legal action and/or penalties. Microeconomics tells us exactly what will happen! Consider the following graph:
If the market for masks is left to its own devices, the price would rise to Pe, which we've assumed is $10/mask. However, the government, Google, or whomever, has determined that Pc (let's assume $5/mask) is the highest the price can go. So what you ask? We don't want any poor sap consumer to pay too much, but look what happens. Remember what I told you about holding a gun to a suppliers head? Well, you can't force suppliers to make more masks than they want. Per the above supply curve (in Red), at $5 suppliers will only supply Q1 units of N95 masks. Again, you say "big deal." But wait, at $5/mask, Q4 customers are lined up for masks! Now do you see the dilemma? The market will only produce Q1, but consumers are demanding Q4. Q4>Q1 and we call this in economics a SHORTAGE! The constrained market will not produce enough masks to satisfy everyone who wants one. Herein lies the beauty of the supply and demand model in its predictive power -- this is exactly what happened! Front line workers were unable to get enough masks & PPE at the beginning of the pandemic! My own son, a Physician's Assistant in oncology and urgent care, was unable to get enough PPE. Do you see the rub? The best intentions by our own government, and well meaning search engines like Google, produced life threatening results. Honestly, I'm sure frontline workers would have paid $100/mask at this point! By the way, this illustrates another remarkable outcome of supply and demand. At the equilibrium of $10 (if we would just allow it), people like my son, who would be willing to pay $100, only have to pay $10. Isn't that wonderful? There are so many benefits accruing from the equilibrium price, that it makes me giddy! Yes, I'm an econ nerd!
Another fundamental lesson of economics -- markets will not be stopped! Black markets thrived in the Former Soviet Union. In fact, they became a way of life. While we were busy constraining our productive mask capability through arcane price gouging laws, China was lurking! They had no compunction with price gouging and jumped right into the mask marketplace. They increased production from 1 billion to 70 billion masks! I read about some enterprising tech types in San Francisco who scoured the globe for PPE, connecting buyers and sellers. I'm sure they weren't constrained by price controls, as their "customers" were hospitals.
So, the next time you see anything about price controls (rent control, minimum wage, etc.) remember the PPE example. Price controls, of any kind, distort the marketplace, and in this particular case, lead to life threatening results.
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