>>Valley Patriot>> |
Gasoline, of course, is not the only commodity whose price is skyrocketing. Every hurricane sees plywood prices shoot up as people desperately try to protect their homes or businesses that might be damaged. You can also be sure that heating oil prices will hit historically high levels this winter. Many people are angry and resentful. They are saying, “If people were just not so greedy, we wouldn’t have to suffer these high prices and life could go on the way it was. The government should pass a law… .” They should think again. The argument typically goes something like this: The oil companies and gas station owners didn’t pay higher prices for the inventory they are now selling, so it is immoral for them to increase prices to their customers — meaning, of course, to the person protesting the price increase. Before we re-think this logic, it is instructive to examine the hypocrisy of those complaining so loudly and with such a self-righteous tone. In fact, the reader should brace him- or herself before reading the next few paragraphs. You, yes you, might need to fess up to a little hypocrisy yourself. Try on the following example: You bought your house 10 years ago for, say $250,000, and it is now “worth” three times what you paid for it or around $750,000. Sure, you’ve put in a few improvements, say $30,000 or so, and paid the taxes, but you have also lived in it for 10 years and you certainly didn’t dole out anywhere near $500,000. There may also have been some inflation, say 40 percent, so, to get your investment back, you need roughly an extra $140,000. Therefore, the fair/no-gouging price should be about $390,000. How many of our readers would set the asking price at $390,000 instead of the $750,000 market price? No takers? You are all just a bunch of heartless price-gougers and you should all be locked up!! But you protest! You say that you didn’t set the price, the market did. And people willingly agree to pay this price. In fact, if you lowered your price to $700,000 — still big-time price gouging — people would literally beg you to take their money. I fail to see a difference between this and $3.00 gas prices. You might argue that you don’t resent profits on long-term investments but you think short-term, windfall profits are immoral. OK, think about putting your house up for sale as described above. On Friday you sit down with your realtor and she tells you that you can get $750,000 and this is where you should set your price. You agree and tell her to put your house for sale on the Multiple Listing Service for $750,000. Then, over the weekend, the Federal Reserve drops the prime rate 2 percent and mortgage rates are poised to drop from 5 percent to 3 percent. Millions more Americans can now afford to buy homes at this lower interest rate. At 8:00 a.m. Monday your realtor calls you in a frenzy and says that you now can easily get $850,000 for your property. Wow, a windfall profit of an additional $100,000! But, of course, you just couldn’t live with yourself if you made this extra profit, so you tell your realtor to keep the price at $750,000. Right! Fat chance! Hurricanes, tornados, interest rate changes … what’s the difference? The only difference is your perspective. In one case you want to buy the asset with an increased market price and in the other you want to sell it. The price-gouging logic is the same. People hate to see others profit at their expense. All I can say is, “That’s tough. Grow up.” The few brave liberals, and in particular liberal politicians, that dare to read this column might argue, “Yeah, what you say is true, but in the case of big corporations profiting while ‘little people’ are paying, we can wield the fist of government and stop those evil corporations from increasing their prices.” They say this knowing that the “little people” have more votes than big corporations, so that they can sell this violation of private property rights at election time. Corporations have given up trying to defend property rights and explaining the benefits of leaving prices to market forces, especially since most of the voters are poorly educated and don’t have even a rudimentary understanding of basic economics. Our only hope is that those who can read and exercise their rational faculties can also understand that when prices rise during a shortage, it is a good thing! Why is that? There are at least four excellent reasons. First, when a commodity is in short supply, higher prices discourage uses that have low value. Every one percent increase in a product’s price convinces a small percentage of marginal consumers that they should forego consumption. This tends to reduce — not eliminate, but reduce — the shortage so that those who have high-value uses for the commodity can continue to get the product. Second, price increases trigger the use of substitute products for a commodity in short supply. If a product is used in multiple applications, it is rarely the only product that can fill each of those needs. One application might require the scarce product, but other applications have other alternatives. When the scarce product price rises, users will substitute one of the alternatives that are not in short supply. This will free up the scarce commodity for those uses where its availability is most critical. Third, when prices rise potential providers are encouraged – by higher profits — to provide more of the product or to provide alternative products to meet the application in need. In some cases, this leads to a rapid increase in supply and in other cases it may take longer. Supply increases can come from moving inventory from places having surpluses to places of scarcity. For items such as plywood, this usually takes only a few days. Additional supplies can also come from increases in production. While this may take somewhat longer than shifting inventories, it can happen rapidly – e.g., by adding a third shift – if profits are sufficient. Inventing an alternative product to meet the application’s need is also encouraged by higher prices, but in most cases this takes the longest amount of time. Fourth and finally, the possibility that a product might be in short supply in the future leads speculators to purchase excess supplies of the product in advance of a shortage, precisely because they might reap a windfall profit if the product’s price rises. Much of the time they make no profit or lose money because a shortage does not materialize. But they persist, precisely because when an unusual shortage does arise, they make large profits. The extra supply the speculators have on hand serves to moderate shortages when they do occur. Less waste, use of alternative products, importation of supplies from areas of surplus, greater production, and supplies provided by speculators that otherwise would not exist — all of these are the mechanisms the market uses to solve the problem of supply shortages. When do-gooders scream, “price gouging!” and the government outlaws “windfall profits,” all of these market mechanisms are short-circuited. Precious commodities are used wastefully, alternative products or supplies are not exploited, producers are slow to increase production, inventors are less excited about discovering alternatives, and speculators don’t invest in reserve supplies. What is the end result? Shortages, long lines, economic waste, and inefficiencies. These, in turn, translate to increased human suffering. Suffering that is prolonged instead of rapidly overcome. Price fluctuations and profit variations, both up and down, are the signals used by the marketplace to communicate information to producers, consumers, investors, and inventors. If you stop these signals, the economy can’t respond and the excesses/shortages of goods and services can’t be corrected. Dr. Ormsby is a member of the North Andover School Committee. He is a graduate of Cornell and has a doctorate from MIT. If you have any questions or comments, you can contact Dr. Ormsby via email: ccormsby@comcast.net *Send your questions
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Gasoline prices peaked at $3.50 per
gallon and are now almost $3.00 per gallon. Katrina and
Rita whacked our production of oil and gas in the Gulf of
Mexico and also our refineries … commodities and
facilities that already were in short supply. Now prices
have shot up and people are angry. Even the
president’s advisors are threatening to punish
anyone caught “price gouging”.