Most economists oppose price controlsespecially those following a disaster or other unexpected event (commonly referred to as ‘anti-price gouging legislation’). However, UMASS-Amherst economist Isabella Weber objects. She tweets: “One of the problems with [the supply and demand diagram] is that it misses a crucial dimension: time. When it comes to price gouging in emergency situations, that’s a pretty big problem.” This tweet has generated numerous responses from various economists, most of whom pointed her to the supply and demand model do take time into account: the x-axis is properly labeled ‘quantity per unit time’. (My late, great PhD professor, Walter Williams, would deduct points from anyone who wrote the x-axis only as quantity). Moreover, both supply and demand become more elastic over time.
These objections are valid, but I think they miss the claim Weber is making, and the larger, economic mistake she is making. Weber argues that price controls do not have the negative effects of deadweight loss when the supply of a good is fixed and the timeline before it is released is long. Let us analyze her claim first on its own merits and then through a richer economic lens.
Weber approaches this problem from the perspective of Marshallian welfare economics, in which the performance of a market is assessed based on whether the total surplus (the profits from trade for the producer plus the profits from trade for the consumer) is not maximized. Calculating these profits from trading is quite simple: for the consumer, it is simply the difference between what a consumer is willingly pay for each unit consumed and what they are must pay for each unit consumed. For the producer, the profit from trade is the difference between the price the seller receives for each good sold and what he is willing to sell for each good sold. So the total surplus (total profit from trade) is the consumer surplus (consumer profit from trade) plus the producer surplus (producer profit from trade).
Two very important things to note: 1) how much surplus is generated in the market depends on the quantity exchanged in the market. If the quantity exchanged decreases, the total surplus will decrease (and vice versa). 2) How the surplus is divided between consumers and producers depends on the price. In general, a higher price implies lower consumer surplus and higher producer surplus (all else held equal).
From a strictly Marshallian welfare economics perspective, Weber’s claim is correct. When supply is fixed (i.e., perfectly inelastic) and there is no time to increase supply or make the curve more elastic, price gouging legislation will not result in a deadweight loss. Because the quantity does not change, setting a price ceiling simply shifts the profits from trade from the producer to the consumer. The total surplus on the market does not change; there is no deadweight loss because the quantity on the market does not change.
However, from a broader, richer economic perspective, where we think about how people actually behave when faced with different choices, her point is flawed. Price controls will still lead to shortages because the quantity demanded exceeds the quantity supplied. Even though there is no dead weight loss, the costs of these shortages still arise: queuing, hoarding, etc. Furthermore, the costs of price ceilings persist longer, as keeping the price artificially low discourages the supply curve from moving to become elastic and/or grow. otherwise they would. These are very real costs and taking them into account shows that, even with fixed supply, price controls make everyone worse off.
So by comparing these two situations (price ceilings where producer surplus is transferred to the consumer, but the consumer and producer bear much higher total costs over a longer period of time, or prices rise, the consumer surplus is transferred to the producer, but no additional costs are imposed), but price ceilings still have undesirable effects, especially after a disaster.
And there are many more possible objections. In a conversation with me on Facebook, retired Texas Tech economist Michael Giberson pointed out that there is no specific economic justification for favoring consumers over producers in this (or any other) exchange. Another is that there is no reason to think that the distribution of goods to consumers will be more ‘equitable’.
Furthermore, if Kevin Corcoran reminded us recentlywe want to prevent single-phase thinking from penetrating Weber’s claim. Price control laws have long-lasting consequences by changing suppliers’ incentives in return for prepare for a disaster. Like economist Benjamin Zycher showsWartime price controls discourage producers from building war stocks equipment in peacetime. The same applies to non-defense goods. Stockpiling is expensive; it takes storage space away from goods that can be sold more quickly. If companies want to stockpile, they must be able to count on higher prices in the future. If they know they cannot charge higher prices in the future, the costs of stockpiling will outweigh the benefits. Companies will have fewer goods on hand, so that when the disaster occurs, there will be fewer goods available for the aftermath. The best time to end price controls is before a disaster. The second best time is now.
In short, Isabella Weber’s tweet is mathematically correct, but economically incorrect. It is internally consistent and logical, but does not contain economic aspects. We must always look beyond the model, to the reality that the model simulates.
Jon Murphy is an assistant professor of economics at Nicholls State University.