Price is the market mechanism that balances supply and demand. If supply increases, or demand decreases, or both, price will fall. Conversely, if supply decreases or demand increases, or both, price will rise.
Some markets are extremely liquid and this price change happens quickly and frequently – for example the price you pay for gasoline. The same station might change its price up or down a few pennies every day. The vast majority of the time supply and demand move in small increments and changes in price are hardly noticeable.
However, there are times when markets are shocked. Hurricanes in FL might increase the demand for plywood while at the same time supply is diminished both in stores and through strained supply chains. This is where well-meaning politicians have often stepped in and enacted laws forcing business to keep prices at the level they were before the shock came. While well-intended, whether by law or a business owner’s personal altruism, not raising prices in a time like this can hurt those it was most designed to help.
In the hurricane example, if prices of plywood are allowed to rise, guys with pickup trucks in surrounding states might anticipate the need, buy the surplus in their region, and drive to FL reselling to those who need in. Yes they do this at a profit, sometimes. But, if the market need is misjudged they could end up taking a loss. This is the essence of being an entrepreneur – forecasting market needs and taking a risk to meet them. When the law will not allow businesses to increase the price of plywood, those same “guys with pickup trucks” will simply stay home, and the people most in need of plywood will have to do without, until the inadequate (for the situation) supply chains of existing businesses like Lowes or Home Depot are able to catch up. NOW Supplements, Vitam... Buy New $9.92 ($0.04 / Count) (as of 04:43 UTC - Details)
But that’s not the only consequence. If prices remain low, it signals to consumers that everything is normal. The first ones in line might buy more plywood than their actual need, leaving less for the people who arrive later.
Let’s consider a different, perhaps more personal example. The whole nation just experienced this first hand with toilet paper. When stores first began to notice the increased demand for toilet paper they had three options: 1) do nothing, 2) restrict the number of items each customer could buy, or 3) increase the price. Unfortunately, most stores initially chose “do nothing.” This led to customers buying more than could satisfy their immediate needs, leaving others without the ability to satisfy their needs.
Now that the shortage has spread beyond toilet paper into other goods like groceries, many stores have begun enforcing #2 – restricting how many items each customer can buy. The conceit of this should be clear after a moment of reflection. It is the same problem that plagues all central planners. How could they possibly know the right number of items to meet the needs of each customer’s unique situation? Only the customer could possibly know that. Here’s a for instance – Publix grocery stores has instituted a policy of not selling more than 2 of the same item to any one customer. Seems reasonable, right? Yet their policy will allow you to buy 50 quarts of ice cream as long as you select at least 25 different varieties, but will not allow you to get 3 quarts of your favorite triple chocolate truffle variety. Sure, maybe you won’t eat all that ice cream in one sitting, but why should it be Publix’ decision how much you buy. They are not qualified to judge your unique situation and needs.
How about another example? Their policy would restrict me from buying more than 2 cans of Bar Harbor brand condensed New England style clam chowder (it’s fantastic, by the way). But why? How do they know the right amount for me to buy? It just so happens that with a large family, we eat at least 4 cans in a single meal. So for me buying 2 cans would be the same as half a meal. If the next person in line is single and also buying two cans that could be the equivalent of 4 meals for them. Why should Publix limit me to ½ a meal while allowing another person to purchase 4 meals?
So we’re left with option #3 – increasing price. If stores had begun to raise the price of toilet paper when demand surged, people would naturally respond to the higher price and conserve. With scarce resources, they would consider their immediate needs more carefully. This would create multiple positive outcomes. First, it would leave more supply on the shelves for other consumers. Next, it would cause stores to shift supply chains to support the now more profitable toilet paper, moving more supply out of warehouses and onto store shelves quickly. Finally, the increased supply would have most likely calmed the panic and it would not have spread to grocery items and other areas.
You might ask why not just ask people to be considerate and only buy what is necessary and no more. Do you even know human nature? Humans respond to incentives, and the only equitable way to enforce conservation is to charge the correct market price that reflects the current balance of supply and demand and allow the customer to choose how they will allocate their resources.
Still not convinced this would work? I would just note that my local Publix is out of ground beef, but has plenty of ribeye in stock. Price does matter, and the entrepreneur who responds appropriately is an economic hero.