Last Updated on November 30, 2020
One of the earliest and most noticeable effects of COVID-19 was the mad rush on common household items such as toilet paper. The result was that some households had enough toilet paper to last for years while others were forced to clean themselves by other means, such as napkins and washcloths. The prolonged empty shelves were not caused by the coronavirus, but rather were a price phenomenon. That rising prices are often deemed to be “gouging” resulting from greed culminated in a massive shortage of toilet paper. In this article we illustrate why it is best to let prices fluctuate with supply and demand, and why when they are not allowed to move freely shortages inevitably occur.
Table of Contents
The Role of Prices
It goes without saying that, for any given product, sellers want to charge as much as possible while consumers want to pay as little as they can. What ultimately creates the “happy middle” where prices settle is supply and demand.
Costs serve several functions in a price-coordinated market, some of which we survey below. In the final analysis, prices serve as an indication of what are often unseen forces at play in a given product’s market. This allows both producers and consumers to react to conditions that they may not understand and often do not even realize exist.
“Prices are like thermometer readings—and a patient with a fever is not going to be helped by plunging the thermometer into ice waster to lower the reading. On the contrary, if we were to take the new readings seriously and imagine that the patient’s fever was over, the dangers would be even greater, now that the underlying reality was being ignored.”
Thomas Sowell
When dealing with flash shortages such as supplies during a pandemic or natural disaster, there are two roles of higher prices that must be understood. First, prices force resources to be rationed. Secondly, prices cause more of a resource to be produced and supplied. Both of these result in more supply being available for those who need it.
Higher Prices Force More Rationing & Conservation
There are no unlimited resources on earth; therefore, everything must be rationed. This can be accomplished by government (socialism & communism); by random allocation such as lottery; by violence; or by price. In a free market economy, prices force rationing; the more a resource costs the more it (or its components) will be shared.
It is axiomatic in economics that less of a resource will be purchased at a higher price than at a lower price. When prices rise in response to a shortage, less is purchased by consumers, leaving more available to be bought by someone else. At the same time, it causes society to more careful with how they use the resource, which leads to conservation. The reason we are more careful with our cars than a bottle of water is because the replacement cost for a vehicle is thousands of dollars (used, and even more if new) while a bottle of water can be had for under $1.
If prices of toilet paper had risen when the hoarding began, said hoarding would have immediately slowed to a crawl. Family shoppers accustomed to buying packs of Charmin for $5 wouldn’t be so eager to stockpile if they were $7. This would leave more on the shelves for others in need to buy.
We see this happen with hotel rooms when a hurricane makes landfall. If hotel prices were allowed to freely increase to the level dictated by supply & demand, people would think twice about moving into a hotel unless it was absolutely necessary. Further, instead of getting a separate room for the kids and one for the mother-in-law, a family would be more inclined to pile into the same room to save money. The end result being that more hotel rooms would be available to those in need.
Sadly, because of the anger directed at hotels that raise prices in response to increased demand, and the subsequent ability of politicians to buy votes by coming out against it, more people are left on the streets during disasters since hotel rooms are not rationed efficiently.
The ongoing effects of such policies can be clearly seen in areas where rent controlled housing is prevalent. With housing prices artificially suppressed, more people move away from home and fewer seek roommates to share costs. In the end, there are fewer dwelling places available than if there had been no rent control and prices were allowed to fluctuate with supply and demand.
Artificially low prices also carry major hidden costs, beginning with poorer quality. Again using housing as an example, if a landlord knows that there is a shortage on housing he has little incentive to keep the property in good condition since there will always be someone in need of a place to live, having little choice but to accept anything they can get.
Likewise, artificially low prices incentivizes dishonesty among landlords. If he can’t make money running a clean business because he isn’t allowed to charge enough to cover his costs, he will either let the property deteriorate or turn to dirty tactics.
Higher Prices Bring More Resources
One of the key roles of prices is that they direct resources where they are most in demand.
Just as it is undeniable that consumers will purchase less of a product at a higher price than they would at a lower price, it is also unquestionable that businesses will produce more of what makes the most money.
Why would a supplier make more toilet paper if they aren’t going to make more money? In fact, without price hikes, producing extra toilet paper will cost the company money. It costs more in power and labor (including overtime) to ramp up manufacturing than to produce the item during the regular course of business. Even worse from the company’s perspective, since people are hoarding toilet paper now, there will be less purchased in the future. In the long run, little extra will be sold.
In short, without a corresponding price hike, it would stupid for producers to make more toilet paper, regardless of how bare the shelves are. But if prices were allowed to rise with the increased demand, more supply would quickly flow into stores. This would stablize prices and soon they would return to the previous lower levels, perhaps even lower if the toilet paper market becomes glutted.
As I write this in early 2020, housing prices are soaring as multiple factors have converged to make the demand for homes skyrocket. At the same time, one can’t drive down the street without passing new home developments or apartment complexes being built. These new dwelling places are not being constructed directly in response to there being a high demand for places to live. Rather, they are being built because of the higher prices that flowed from the higher demand. As with everything, higher prices bring more supply.
In response to a pending or just passed hurricane, gas stations often run out of fuel supply. If they could freely inflate prices (which would be temporary), the likelihood of not having enough gasoline to supply the needs of society are drastically reduced. Not only would customers buy only what they need (forgoing filling extra portable containers, boats, and multiple cars), but suppliers would race to the area as fast as they could to take advantage of the high prices.
This happened on national scale in the 1970’s where government capped gas prices led to long lines and massive shortages. Within months of the price caps being removed by Ronald Reagan in 1981, there were no lines at the pump and prices were lower than the government imposed ceiling.
Closing Thought
When shortages arise, people tend to acquire more than they need. If prices are not allowed to fluctuate with the increased demand, a shortage will quickly become a major problem for part of society who are unable to have their needs met. If toilet paper rose in proportion to the supply/demand imbalance, hoarding would have been drastically reduced and multiple companies would have rushed to offer greater supply at the higher profit margin. This would have brought the price back down in short order.
Unfortunately, the public outcry and pressure from politicians almost always prevents this from happening. Whether it is housing, gasoline, water after a natural disaster, or toilet paper, it is society as a whole that suffers the consequences.
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