Hurricane Sandy left devastation in its wake and has created numerous hardships for the residents of the area that will continue for some time to come. One of the problems affecting most residents, even those whose homes were not significantly damaged or did not lose electricity, is the ongoing gas shortage. New York State, following on the heals of New Jersey, announced gas rationing to go into effect today. This is in response to the continuing long lines at service stations throughout the area. The problem is that these mechanisms do not allocate gas fairly, wastes valuable resources, and prolongs the suffering.
Long lines mean that people and businesses are diverted from their usual activities to acquire this needed commodity. The wait is frustrating and leads to anger and unrest often because some people in line have a very high immediate need for gas while others have noticeably less need. Some people need gas to run their business, or to operate their emergency vehicles, others like retired people need gas because they will drive to the post office and store 3 times a week; some need gas to run their generators because the power is still out at their business or home, others need gas to run their lawn mower this week.
The allocation mechanism with lines is simple though; it is first come, first served. Unfortunately, the people with the most time to wait in line, like a retired person for example, are also the ones who probably have lesser need for the gasoline right now. Those desperate for gas are more likely to try to cut ahead in line which is sometimes enough to provoke violence. This is a reason police officers have been assigned to keep order at service stations. But it also means more worker time (policemen) is diverted from other activities towards gas rationing.
In the end, the line, and the rationing, will mean that everyone lucky enough to get gas after the long wait (and some might be turned away if gas runs out) will get the same amount; in other words, high need people and low need people will be treated equally. Of course, government leaders have appealed to people to buy only what you need, but because there is uncertainty about when gas supplies will be restored, every individual believes they need the maximum amount they can get, and so these appeals are rarely heeded.
There is a fairer and simpler allocation mechanism available, but unfortunately most people don’t understand it and would not accept it in this situation. Nonetheless, this mechanism would assure that the limited available gas goes to the consumers and businesses that need it the most. The mechanism would eliminate the lines and allow people to use their valuable time more productively. And the mechanism would help to bring greater gas supplies to the area more quickly so that life could return to normal.
That mechanism is the free market price mechanism. Here’s how it would work. First, when the storm hit, gas supplies suddenly dropped, largely because electricity outages froze the pumps. The sudden need for gas for generators and because of future uncertainty about supply, led to an increase in demand and the formation of lines. In a free market, service stations with gasoline to sell would recognize the line as a gas shortage and would raise their price immediately to make more profit. Knowing what price is needed will be difficult with so much uncertainty, but a rule of thumb would be to raise the price until the line disappears, and you return to your normal sales rate. However if you fear that supplies will not be arriving as usually scheduled, the owner might raise the price even further to shorten the sales rate. What price would be needed is hard to guess, but perhaps in this situation the price might be raised to $8 or $10 per gallon, or even more. Different service stations would raise the price to different levels. Those with a lower price increase would see their gas disappear faster as consumers would choose the lower priced gas.
With high prices, demand will fall. People with low gas needs will conserve gas or stay home and wait for the prices to fall. People with intermediate needs will look for energy alternatives. They might drive to Pennsylvania to get the cheaper gas because even going out of the way is cheaper than paying the high local price. Still, the people who most need the gas, for example, the emergency and delivery vehicles, will recognize their high need and will buy gas despite the high price.
I understand that this mechanism does not produce happy people, but then neither does waiting in line with the alternative mechanism. The underlying shock remains the same; there is still, say, 50% less gas to go around and somebody is not going to get their usual amount. There is no way around that until gas supplies return to normal. However, with the price mechanism the businesses and individuals who need gas the most at this moment will be able to drive into a service station, without waiting in line, and buy gas in the midst of the crisis.
Furthermore, the price mechanism will send a signal to gas suppliers elsewhere that if you can quickly move gas into the area, you can make a big profit. The bigger the price increase, the bigger the profit and the more swiftly profit seeking oil companies will move gasoline into the area. Consider a simple example. A tanker truck is about to deliver gasoline to a service station in Pennsylvania. But when the price rises in NJ, it makes sense to give up the PA delivery and sell it for a higher price in NJ. Since the station is now selling gas for $8, say, they will pay the tanker company much more for the shipment. If the price rose to $12 a gallon … then tanker trucks from Colorado might begin to show up! The supply response will be larger the greater the price increases. In contrast, when prices are kept low, as is typical in these situations, oil companies have no greater incentive to move gas to NY and NJ and so the gas shortages will last longer.
Of course, the price mechanism creates some equity problems and this is the major reason it is rejected by most people. The first reaction to price increases is to ask how a service station owner could be so callous as to try to make more profit when people are suffering in the aftermath of a natural disaster. The second reaction would be that wealthy people can afford the high prices and will get all the gas, while poorer people will suffer.
There are several ways to assure greater fairness despite the high prices though. First, is to recognize that high prices assure that gas goes to the greatest needs and that may not always be to wealthier people. (For example, consider a small delivery business with high daily gasoline needs). Second, recognize that the needs of poorer people are not always better served with low prices and lines. Poorer people still need to wait in long lines, probably taking them away from a job with a necessary income. Furthermore, lines allocate more on the basis of luck and persistence rather than based on low income. Third, if moral indignation is to be raised, it is better if it is turned to social pressure to return the extra profit to the community rather than pressure to avoid the price increases in the first place. I imagine that even service station owners, living in a distressed community, will exhibit compassion for their neighbors. Suppose service station owners who increase their prices, decided to open a window and offer cash payments to buy gasoline to customers in distress. That owner would contribute money to a family whose home was destroyed but not to the family whose lawn might not be mowed this week. Or, perhaps the owners would contribute a large share of the profit to local charities who are better equipped to determine who in the community is in more desperate need. Relief organizations can help poorer families too, perhaps by giving out gas vouchers that can be redeemed at local service stations and are reimbursable to the gas supplier at full market price at the time of the transaction. Many other solutions like this exist that would allow the price mechanism to allocate gas on the basis of greatest need, but at the same time provide compensation to the poorer families and to those in most distress in the community.
The price mechanism will not work perfectly but it seems likely to work more efficiently and will resolve the problems faster than the alternative. However, the price mechanism is never given a chance. This is largely because the general public and policy makers do not understand or accept that profit seeking behavior in this situation will eliminate lines, allocate temporarily scarce gasoline to its most important uses, and promote a more rapid return to normal supply levels. Profit seeking in this instance, (though not in all instances I should add), serve the public interest as well as the private interest. Nevertheless, although the price mechanism is accepted in normal times, people do not accept its benefits in situations like this. Instead, politicians have put into place anti-market legislation such as price gouging laws, which appease the public, but which only serve to make a very bad situation even worse.
Steve Suranovic teaches international trade, international finance and microeconomics at The George Washington University. His research focuses on international trade policy, fairness and equity issues, and behavioral economics. He has a book titled “A Moderate Compromise: Economic Policy Choice in an Era of Globalization” published by Palgrave-Macmillan. This is cross posted from The International Economic Policy Blog.
Steve Suranovic is an Economics Professor at the George Washington University in Washington DC where he introduces students to the principles of microeconomics and international economics. His recent book is titled “A Moderate Compromise: Economic Policy Choice in an Era of Globalization” published by Palgrave-Macmillan.