As the price for gasoline rises, politicians hear increased calls for regulation of gas prices. We hear news stories of hotels increasing prices for victims of hurricane Katrina, and prices for needed goods in the destructed area could rise, too.
In Wichita, when gasoline prices rose rapidly, someone told me that this was price gouging, because the price the gas stations pay for gasoline hasn’t increased yet. I’m sure that’s true, their cost hasn’t increased yet, as they’re still selling gasoline they already bought some time ago. This analysis, however, doesn’t consider the most important role of prices: to strike a balance between supply and demand. That’s what prices do.
Consider what the economist Walter E. Williams wrote about plywood prices:
Windfall profits are indeed profits far beyond what’s necessary for an entrepreneur to stay in business, but windfall profits also play a vital role. Windfall profits signal that a human want is not being met. Resources emerge to meet that want. For example, when Hurricane Andrew devastated parts of South Florida, plywood prices skyrocketed. Florida’s attorney general threatened actions against companies for price-gouging.
Those windfall profits conveyed messages to the rest of the economy. Let’s say that pre-hurricane plywood prices were $10 a sheet and afterward they were $20. That profit potential created a powerful signal. Instead of plywood manufacturers selling their plywood inventory to, say, Pennsylvania wholesalers for $8 a sheet, they were more than happy to ship them to Floridian wholesalers for higher prices. Wholesalers in other states were happy to sell their plywood to Floridians for higher prices. Since plywood supplies were moving to Florida, plywood prices elsewhere rose.
From a social point of view, this is wonderful. Say I planned to spend a Saturday afternoon building a house for my dog. I go to my neighborhood lumberyard in Pennsylvania expecting to pay $10 for a plywood sheet, and get there and find out it’s $18. I say, “The heck with the dog; let him sleep in the rain!” I have voluntarily made a plywood sheet available for a more valuable use — rebuilding the house of a human.
None of these and other voluntary actions making plywood available to Floridians would happen if price controls were slapped on plywood making the pre- and post-hurricane prices the same. Freely fluctuating prices, including the potential for windfall profits, encourage people to do voluntarily what’s in the social interest.
In free and open markets, profits are to be praised — not scorned, as economic and political charlatans would have us do.
We might consider the prices for hotel rooms. As families evacuated before (or after) Katrina struck, they needed hotel rooms. If the usual price for a hotel room was, say, $50, and hotel operators can’t increase their prices, there will be a shortage of hotel rooms. Why is this? Think of the Jones family with children. At a room price of $50, the Jones family might take two rooms, one for the parents, and another for the children. If the hotel operator is allowed to increase prices, the room price might rise to, say, $100. At that price, the Jones family might decide they could all stay in one room. That makes the second room, the room the Jones family children would have occupied at a price of $50, available for the Smith family. Otherwise, the Jones family children would be in the second room, and the Smith family is on the street, or has to drive farther to find a room.
Yes, the Smith family had to pay $100 for a room when they would prefer to pay only $50, but if the price is $50, there is no hotel room available for them.
Some people might object that the hotel operator is unjustly enriched by being able to sell hotel rooms for $100, when normally they fetch only $50. But what is the alternative? Is there anyone who has the power to say to the Jones family that they should all stay in one room, leaving a room free for the Smith family? Or, in the case of gasoline prices held artificially low through price controls, someone has to judge whose use of gasoline is more valued.
But if the prices of hotel rooms, plywood, and gasoline are allowed to fluctuate, each person is free to make their own judgment as to how much they want to consume. If the Jones family really wants two hotel rooms, they can have them. If Dr. Williams really wants to build the doghouse, he can. But people acting as they do — demanding less of something as its price rises — there will be more hotel rooms or plywood available for others. If the price of plywood in Florida is controlled so that it can’t increase, the cost of plywood in Pennsylvania will likely be the same $10 as it always is. So plywood is used in Pennsylvania to make doghouses as people in Florida need plywood to patch the roofs of the homes so that they can stay dry.
That’s what is important about prices. They represent people voluntarily — and that’s a very important word that Dr. Williams used — adjusting their behavior. The alternative is shortages, gas lines, rationing, government control, and commissions deciding who gets what at what price — all the signs of a planned economy. That does no one any good.
In the case of my friend in Wichita, who was going to make a weekend trip that would require about 100 gallons of gasoline in a vehicle that gets 12 miles per gallon, I suggested renting a car that gets better fuel economy. That’s what he did. In the end, he’s saving about $100, even considering the cost of car rental, and he’s making about 50 gallons of gasoline available to someone else. That’s the power of prices in action.