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November 7, 2012

Economics 101 Works! Price Controls Lead to Gas Lines

November 7, 2012
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After getting whacked by a hurricane, the poor citizens of New York and New Jersey have to suffer the added indignity of government price controls on gasoline. It is not the hurricane and associated supply disruption per se causing the terrible shortages and lines, but rather the government’s interference with the price allocation mechanism of the free market. This is exactly what happened in the 1970s, and it is disturbing that Governor Chris Christie—considered by many to be a strong conservative Republican candidate for 2016—is stooping to such blatant restrictions that defy basic economics.

Price Ceiling Lead to Shortages

When a writer wants to rhetorically drive home his point on an economic issue, he will often say, “This is Econ 101.” But in this case, it really is textbook economics—see for example Chapter 17 in my book, Lessons for the Young Economist, in which I actually used an illustrative example of a government causing shortages in the gasoline market during a hurricane.

The theory here is simple and irresistible: Other things equal, when the price of something goes up, consumers want to buy less of it, while producers want to sell more of it. The “market-clearing price” is that which exactly balances quantity supplied with quantity demanded. If the actual price for some reason is below the market-clearing price, then there will be a shortage—consumers will be trying to buy more units of the product than producers want to sell them. This will push up the price toward the stable, market-clearing level.

On the other hand, if the actual price for some reason is initially too high, then producers will be trying to sell more units than consumers want to buy, so there will be a glut. Producers will cut the price to unload the excess inventory, pushing it back toward the stable market-clearing level.

Now in the New Jersey and New York markets, there was originally an equilibrium in the retail gasoline market—let’s say $3.50/gallon for a round number. Then Hurricane Sandy struck, making some stations unable to sell their product (because they had no electricity) and making it difficult to ship new supplies into the region. Thus the supply of gasoline was severely restricted.

At the same time, the demand for gasoline increased, because the mass transit infrastructure was impaired. In order to get to work, many commuters in New Jersey and especially New York were now trying to drive, rather than take the subway or train.

Thus Hurricane Sandy caused (a) a reduction in supply and (b) an increase in demand for gasoline. This means that the market-clearing price should have risen, perhaps significantly—let’s say to $7/gallon. By definition, this new market-clearing price is the one that would balance the new forces of supply and demand, meaning that the available quantity of available gasoline would be distributed to the people most willing to pay for it. There would have been no unusual lines or hours spent driving around looking for gas. The only difference would be that gas would have doubled (let’s assume) in price, so that everybody would be extremely careful about driving and would only buy as much gasoline as he or she really needed for a few days at a time.

Yet instead of allowing market prices to do their job, the authorities in the stricken regions warned gas station owners that they would be charged with “price gouging” if they actually had the gall to adjust their terms of business in light of the new reality. Because the actual retail price was not allowed to rise to the new market-clearing level, massive shortages developed. Far more people were trying to buy gasoline than could be satisfied with the available stockpile, and so the authorities had to institute other, non-financial means of rationing, such as the absurdity of needing a certain license plate in order to engage in a voluntary trade with a gas station owner.

Price Controls Discourage Conservative and Paralyze Influx of New Supplies

When a disaster strikes, causing supplies to drop and a panic demand for purposes of hoarding, we want market prices to skyrocket in order to provide the right incentives for everyone. Higher prices encourage conservation on the part of consumers: Rather than filling up the minivan, the soccer mom—seeing a posted price of $7/gallon, perhaps—may think, “Well, let me just buy eight gallons right now to get us through the rest of the week, and we’ll see if the price comes back down as things return to normal. I can carpool with the other moms in the neighborhood to take the kids to school; we don’t all need to be driving this week.”

At the same time, the high price would give incentives for people outside the region to ship in more gasoline. There are all sorts of individuals doing this in the “black market” via ads on Craig’s List and other sites; this news story talks of the police arresting a New York man who drove to a Home Depot 80 miles from his house, where he loaded up 150 gallons of gas in (allegedly unsafe) containers to bring back to his neighbors. If the retail market price were allowed to rise, then professional companies would have a much larger incentive to do the same thing, but on a larger scale and more safely.

Pre-Storm Stockpiling Would Have Been Higher, Too

Some critics have objected to the above type of analysis, claiming that in the immediate aftermath of the hurricane, the transportation infrastructure (such as bridges and ports) was so severely damaged that the local gasoline supplies were effectively fixed. Thus, these critics say, the price controls served a useful social purpose, in preventing a few gasoline retailers from getting rich at the expense of their unfortunate neighbors.

Yet this is a very shortsighted analysis, and fails to appreciate the versatility of a truly free market. Suppose for the sake of argument that Hurricane Sandy completely isolated New York City from the outside world for a few days. Even so, the expectation of anti-gouging rules made the New York residents worse off.

Think of it this way: Meteorologists had given several days’ warning that the “Frankenstorm” was going to be a big one. Residents were stocking up on flashlights, batteries, bottled water, and so forth “just in case.” If we actually enjoyed economic liberty in this country, then the gasoline retailers in the area would have thought, “Hmm, if this storm is as bad as they’re saying, we might be cut off for a few days, and the subways might be flooded. The market in that scenario might bear a price of $7/gallon or even higher. So it makes sense for me to carry a much bigger inventory than I normally do. If the storm is a dud, then I’ll be out a bit of interest I could have earned on my capital, while it’s tied up in the massive inventory that I have to gradually unwind. But if the price does happen to skyrocket, I’ll make a killing.”

Thus, even the amount of gasoline on hand when Hurricane Sandy struck, was itself lower because people in the industry knew full well that the knee-jerk government response is to crack down on “gouging” in such situations. There was not as much incentive to build up large stockpiles in the week before the hurricane hit, as there would have been had retailers believed they actually owned their property and could charge their customers what they wanted for it.

Conclusion

Residents of New Jersey and New York have been hit by a double whammy: First Hurricane Sandy reduced the supply of gasoline while knocking out mass transit, and then the authorities crippled the market economy’s normal mechanism to deal with such situations. As a result, the beleaguered residents not only have to deal with flooding and power outages, but they also have to wait hours in line for gasoline.

Market prices aren’t arbitrary; they serve a social function in communicating important information to buyers and sellers. By cracking down on “gouging,” government officials hindered the flow of information, and crippled the recovery process just as surely as if they banned cell phone use following the hurricane.

It’s true that a free market in gasoline would have meant higher prices immediately after Sandy struck. But if producers had expected such economic freedom, then they would have stockpiled more gasoline before the storm arrived. After the storm hit, the high price would have attracted a much larger and more rapid influx of relief supplies. Finally, even if we completely set aside the issue of supply, the market-clearing price would have encouraged conservation among consumers, so that people only tried to buy gasoline who really needed it.

Critics of course will complain that “only the rich” would be able to afford gasoline in such circumstances, but this is absurd: The vast majority of vehicles on the road aren’t limousines or Ferraris being driven by millionaire playboys. No, most of the people driving are working- or middle-class people running errands and going to work. And also note that if people really are concerned about poor motorists, they can send them money to help pay for the temporarily expensive gas: It’s a lot easier to wire money to a storm-ravaged region than to ship in gallons of gasoline.


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  • James

    for gasoline, retail stations are not the market-clearers, wholesale terminals and regional marketers are. While letting retail prices in the case of hurricane sandy jump to whatever cleared the market would limit demand (and shut down the gas lines), it would kill existing sales. That is why you don’t see it happening. That and also fear of being labeled a price-gouger. And yes, the government can scare retailers into not-gouging, but they are really ineffective in preventing it. Price-gouging accusations are carried by the news more often than not, and retails want to avoid that as much as possible.

    Meanwhile, the government doesn’t tell retail stations what they can sell gasoline for – the cost from the wholesaler (dependent on volumes purchased) is passed on to the consumer with very little margin. retail makes money on snacks. The government can’t really even do anything about price gouging. If your neighboring station is selling for $4.09 and you want to steal his business, you price it at $4.09 or $4.08. If you want to gouge, you either connive with your area stations (next to impossible) or you do things like charge more for credit card purchases or maintain high prices even though your underlying cost (based on the futures price for NYMEX RBOB) has gone down. Takes much longer for retail prices to fall than it does for them to rise. no surprise there.

    “Because the actual retail price was not allowed to rise to the new market-clearing level, massive shortages developed. Far more people were trying to buy gasoline than could be satisfied with the available stockpile, and so the authorities had to institute other, non-financial means of rationing, such as the absurdity of needing a certain license plate in order to engage in a voluntary trade with a gas station owner.”

    This just simply isn’t true. I’m jumping around here but in this case with Sandy its different than it was when we had gas lines in the 70s. The above quote applied back then, but not to Sandy. Then Carter put restrictions on prices b/c he had the power to do so, but also rationing kept prices from naturally moving higher. had prices been allowed to move higher then there would be no gas lines…then.

    But with Sandy its different. The terminals are full. Supply was severly restricted, in both shuttered refineries and terminals (large storage and offloading facilities that serve regional demand by barge and in some cases truck) as well as through a shortage of boats (tankers, barges) to bring product to the retail level.

    However, there are no shortages of gasoline whatsoever in the supply chain where demand is actually measured.

    Where this guy continues to be wrong is that despite what appears to be very obvious, demand actually dropped SHARPLY last week for gasoline. This is inherent in nearly all natural disasters, but also pretty obvious when you think about it. Demand on a retail level apperas to be higher because there are gas lines. But that is not how demand, from an economic standpoint, is measured. Demand is down because electricity shortages put stations out of business temporarily, meaning they couldn’t operate, couldn’t purchase gasoline at a wholesale level (where economic demand is measured) and thus couldn’t sell it. The sharp reduction of available retail locations makes demand seem like it is spiking, and in some areas panic buying may actually see more consumers WANTING gasoline for no real economic reason, but the fact remains that they are unable to get it without waiting on a long long and annoying line. That means in total, less gasoline is consumed and aggregate demand by nearly any real calculation falls.

    Now, in a rebuilding phase, demand will skyrocket putting pressure on prices at the wholesale and futures level which will quickly (but not too quickly) turn into higher prices at the pump. and i assure you many in this same camp (Institute for Energy Research) will say EPA restrictions forced East Coast refineries to close over the past few years and if that didn’t happen we wouldn’t be short of gasoline production. That is total bullshit. What the EPA did or didn’t do DID happen to boost refining margins (the spread between crude oil input costs and what refiners can get for their products) across the entire country. So some refiners on the East Coast had to close – well that was mostly their fault for failing to recognize big changes in the inndustry, namely cheaper sourcs of north american crudes vs. expensive Brent-based imports from places like Nigeria.

    don’t get me wrong, letting the market jack gasoline prices up at the retail level WILL get rid of gas lines quickly. it will slap people in the face who sit on a line for 87 but eschew the neighboring station that only has 97 left, and is charging for it. (this happened to me last week. i paid for 97 b/c i needed the gasoline)

    But it’s got very little to do with government. What chris christie did for good or for ill is manage chaos. perhaps that’s not his purview for some of us, but it certainly is for many more out there who like to see that kind of leadership.

    But he’s also right. High prices do provide an incentive to bring products like gasoline and diesel to markets that want them. But what if other markets want them more? One could argue with the sheer number of diesel-powered generators running that diesel fuel is a tough-to-find commodity these days. Prices surely on a black-market are insane. Retail, if its available at all, are high but not so high as to discourage demand destruction. However, why then are all of our tankers sending diesel to Europe and Latin America instead of right here? Because no matter how much we’re willing to pay – they’re willing to pay more. Even after a hurricane, because despite lines and panic, our demand – due to the hurricane specifically – is sharply lower than it would be in normal times — and thus pales in comparison to that of a normally operating economy.

    Now when something like this happens, price finding mechanisms fail to provide what our perceptions demand. We perceive a shortage of products and demand them despite the price-finding mechanism not actually working in our favor. When that happens, government steps in like it did last week waiving the horrible Jones Act and allowing non-US flagged ships to bring US gasoline from one US port to another. That was good policy. They should do away with it entirely, but that’s not likely to happen.

    And as for pre-storm stockpiling – the East Coast was already so under supplied at a regional level, compared to a five-year average of government data — no amount of pre-storm stockpiling could have possible do any good. And if the author is talking about retail stockpiling, which it seems like he is, well where on earth was he supposed to put it all? They have tanks under their stations with a fixed volume. Fill that up and your at the mercy of a market functioning properly, which due to the storm, was unable to happen. Logistically, with no fault of the government.

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  • http://www.facebook.com/David.J.Bergeron David Bergeron

    When I saw the lines, I assumed there must have been price controls. Great article, but I wish this story had been was more specific about the NY and NJ price gouging laws.

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