Tuesday, August 30, 2005

Out of the Storm Came Forth Reason

The storms affecting the US, and New Orleans in particular, are the subject of an interesting debate on www.divisionoflabour.com on what Americans call ‘price gouging’ and what Brits call ‘profiteering’.

The storms cause damage to houses and people need experts to fix the damage by repairs or replacements. There are a fixed number of repairers in a locality and suddenly demand for their services jumps. What should happen? Should prices be allowed to rise; or should they be fixed by the authorities?

This is an age old problem in economics. Smith discusses the responses to local dearth (famine) in “Wealth of Nations”: VI.v.b.1-53: 524-43: Digression concerning the Corn Trade and Corn Laws”.

Below I reproduce a contribution in the comments section of Division of Labour (forgiveness sought if permission not granted) in which ‘Matt’ responds to ‘Stephen’’ (and ‘doinkicarus) who had argued for price controls:

“Stephen.... Prices are always the best mechanism for distributing goods, and emergencies are no exception.

Consider a hypothetical case where a hurricane has just created a lot of damage. There are plenty of people who will need roof repairs or trees cut or any other given thing. You are right that there is too little time for new firms to begin, and right again in believing that the number of roofers, tree cutters, etc. in the immediate area is likely too little to fulfill demand. Given that there is a set number of roofers, tree cutters, etc. in the immediate area, supply too will also be fixed. The hurricane has just created a huge demand shock for these services, and the first thing to happen is a price jump (when legislation doesn't get in the way that is). If we assume that the market was previously competitive, then the individual roofers and tree cutters will enjoy some newfound economic profit.

So where are we at? The "rich" all have a new shiny house while the rest of us are left with a new sun room? No. This is only the first stage of economics at work. Here is what you missed: There exist firms outside the immediate area who can fulfill the demand. These firms notice all the economic profit being earned and they move in to get a piece of the action. Eventually the prices fall and all the necessary demand is satisfied. Your argument is that this “eventually” is just far too long to wait, after all, we’ll be dead by then right? No. We really don’t have a choice. Consider what happens if some politician agrees with you and concludes: “No, we cannot wait for prices to adjust. We must force them to!” Well, if prices are held at their previous level, then there is no incentive for the out-of-town roofers & tree cutters to enter the area in the first place! So now we are trying to repair the damage with far fewer workers! And the damage will be repaired faster in this situation!?

Now it is true that the people with the highest reservation prices will have their houses fixed in no time, because it is most valuable to them. This does not necessarily have to be “the rich,” some rich people might have other homes to move live at, and will hold off repairs of their vacation home until prices drop. Other possibilities exist. On a side note, that whole line about Bill Gates is just loaded. This type of thing occurs everyday, and people are perfectly fine with it. Children die, you buy ice cream. Couldn’t you have forgone that ice cream and donated your money to buy much needed nutrition for some poor, starving, innocent, young child in some tormented third world country? It isn’t always the rich who make decisions that can appear like “bad outcomes.” This is similarly applied to doinkicarus’ reasoning here.

In a cruel response to doinkicarus’ observation that oftentimes people place values on goods that are higher than they can afford, I say: too bad. I value a brand new HDTV at it’s selling price, I value a new car at it’s selling price, there are plenty of things that all of us want but can’t afford. This is nothing new! The same goes for goods in times of crisis. Some people’s homes might be wiped out and they can’t afford a new one. Well, it certainly is tragic, but too bad. That is the way risk works, if you live where hurricanes live, you might be wiped out. Homes are important, but the person who cannot afford to rebuild must move somewhere else, where they can afford. It is harsh indeed, but it is reality. Now back to the real reality, aid programs and such dole out money to help people who’ve chosen to live in a risky area rebuld at the expense of people who made safer decisions in other parts of the country, so this situation might not exists very much…but that’s a different story.

Endnote: If it gives any credibility to my story, I am from Florida and I have my fair share of experience with hurricanes and natural disasters.

Posted by Matt at August 29, 2005 08:56 PM © Division of Labour 2005”

Now that is why “Division of Labour” is one of the best economics’ Blogs around. Good debate, not abuse; treating the subject with respect, and the other debaters, not with bad manners, and being instructive to all willing to learn. "Congratulations to the people at Division of Labour".


Blogger David_Z said...

I used to blog as "doinkicarus," I can't imagine that I'd ever argue in favor of price controls...

7:41 p.m.  

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