I’m again hearing stories of grocery store shelves emptied of toilet paper. Like many things in life, it’s actually a very simple problem to address but not always easy.
I’ve heard a lot of people exclaim how irrational it is that people are stocking up on toilet paper in response to this particular virus. But, I disagree. It’s actually quite rational.
After all, toilet paper doesn’t expire so it’ll be just as useful in five years as it is today so you don’t have to worry about buying more than you can quickly use since it doesn’t go bad anyway. Therefore, if you’re worried other people are going to raid the shelves it’s perfectly rational to want to get out ahead of it and stock up yourself ASAP.
This then leads to a cycle that feeds upon itself. As more people begin hearing stories of difficulty in obtaining toilet paper they rush to the stores and buy whatever they can get their hands on and the cycle continues.
The problem is with *PRICE.*
I’ll circle back to that.
First, let’s remember the big picture: resources are scarce while demand is infinite. That poses quite the problem, doesn’t it? The goal of economics, however, is to allocate those limited, scarce resources to their highest and best use as efficiently as possible.
Let’s also remember one other important concept: *value* is subjective.
In other words, my neighbor and I may value toilet paper very differently. Maybe he values it less because he doesn’t have a family of five (including three lovely ladies) like I do so he needs less. Or maybe he’s already got a fresh, bulk package from Costco, and I’m on my last roll. Or maybe he lives in the woods and uses leaves. The point being there is not an objective value of toilet paper. Under the hypothetical scenarios I just described I’m willing to pay more for a roll of toilet paper than he’s willing to pay. Value of a good is subjective based on each person’s preferences and needs. This is an important concept to understand not just for this topic but as it pertains to almost all economic policy.
When an economy is operating well there is very little waste and very little shortages. It’s really quite incredible when you think about it… an economy the size of the United States’ with 330 million people across almost 4 million square miles can quite efficiently produce and allocate millions of products and services with relatively few interruptions, without massive waste, etc…
I never cease to be amazed at how many products can be created and how well coordinated an economy can be upon the foundation of independent, self-interested individuals voluntarily engaging in commerce with each other. Note: Read the short essay, “I, Pencil,” by Leonard E. Reed to really put this incredible “unconscious / unplanned / non-directed” coordination in perspective.
But now in 2020 we’ve twice experienced a hiccup with a relatively simple, straightforward product: toilet paper.
So, now, back to price. Price is more than simply what we pay for a good. Price is what makes coordination in a large, complex economy possible. Price facilitates coordination. Without [freely-floating] price it would be impossible for a large, complex economy to function smoothly. There would supply shortages and immense waste across various goods at all times.
Price provides signals to both producers and consumers. High/rising prices indicate demand is high and signals producers to produce more to satisfy the demand. Low/falling prices indicate demand is low and signals producers to produce less so resources aren’t wasted.
Those are the signals prices provide to producers. How about for consumers? High prices cause consumers to economize more than they would at a lower price. All else being equal, consumers buy less of that thing leaving more supply for others. And when they do buy an expensive good they are less wasteful of it. All else being equal, consumers will be more prone to waste things that are cheap/free and common while taking greater care/use less of those goods that are rare and expensive.
Additionally, especially in a country as large as the U.S., we find that certain regions may have excess supply of a product while other regions may be experiencing a shortage either due to local emergencies, locale of manufacturing or a variety of other reasons. Again, in this example, freely-floating prices would signal these mismatches and facilitate the coordination of relocating excess supply to regions of low supply.
More specifically, the prices of a good in a region where there is an excess would be quite low while the price of the same good would be much higher in a region with low supply. So even if the stores didn’t take action, entrepreneurial folks would buy up excess supply at cheap prices and sell for a higher amount in regions with low supply. Yes, the price would be higher in those regions but at least folks could get their hands on desperately needed products previously unavailable to them! This is how supply and demand is efficiently balanced across the country and even the world.
Things begin to go awry when price is not realistic or accurate. An example of this is when price is set by non-economic actors (e.g. politicians) as opposed to being set by market forces via the voluntary exchange and cooperation of freely-acting individuals.
For example, imagine a local government artificially setting a cap on the price of residential homes. Further assume that absent that intervention home prices would be higher as a result of local supply/demand dynamics and the cost of building a home. The end result of this policy action would be supply shortages / excess demand. All the people willing and able to buy a home would not be able to do so because there wouldn’t be sufficient supply. Demand would go unfulfilled. One way to address supply shortages is to produce more. However, with prices artificially capped by government there is no incentive for homebuilders to pursue that endeavor if there is no profit potential in exchange for taking on that risk and effort.
Conversely, imagine if an artificial price floor was set on homes by government as a type of “subsidy” to homebuilders. Further assume that the price floor is set higher than prices would be naturally on their own. In this case, there would be plenty of supply but insufficient demand. Vacant houses would be sitting idle on the market with a bunch of people who might want and need houses but unable to afford them. In that case, we’d have tremendous waste as the resources used to build those homes (labor, materials, etc…) would have been wasted as the house rots.
What does this have to do with TP? After all, as far as I know, in this country government doesn’t set the price of TP.
Over the decades we’ve lost touch with a genuine understanding economics. In today’s world society demonizes people who raise prices of goods in the times of great need / emergencies. We call these people “price gougers,” we shame them or even go so far as to make it illegal and prosecute them. Even during this pandemic we’ve arrested people who have hoarded vast amounts of hand sanitizer and other “important” items at artificially low prices and attempted to sell them at a higher price.
I get it. Profiting in a time of need or emergency leaves a bad taste in our mouths. Maybe it doesn’t “feel” right. That’s especially true if we don’t actually understand the important, nay critical, role prices play in coordinating economic activity and getting supply to who most desperately need it. Hence, the reason for this commentary.
Simply because something feels good, or seems right, doesn’t necessarily mean it leads to “good” results or help people as intended. Oftentimes, such well-intentioned policies actually exacerbate the underlying problem those policies are trying to solve. Ever hear the phrase, “The road to hell is paved with good intentions”?
For example, imagine if the supply chain were allowed to increase prices as they noticed demand was picking up and inventory running low. At those higher prices, there would be less hoarding and greater supply left on the shelves for others to buy. Yes, at a premium price for a short-time but at least people would be more likely to get their hands on toilet paper when they need it and others would be less likely to hoard a bunch of excess they didn’t need.
As that price rises it suddenly becomes VERY profitable to make and ship toilet paper. So, more resources are allocated to that very profitable activity. Producers ramp up production, shippers allocate more cargo space to transporting it while stores free up more shelve space to sell it. As more supply hits the market, the price comes back down and it becomes more affordable again all while greater demand was met throughout the emergency period.
In reality, any price increases that occur today are too minor for the given demand dynamics out of fear of being demonized as a price gouger or even prosecuted. Prices are kept artificially low and people buy up a ton of extra TP they neither need nor can use in a year’s time. As it’s hoarded it becomes scarce and hard to come by even though there is a ton of supply sitting idle in people’s basements.
The one saving grace would be if the hoarders could at least sell the rolls for a higher price on Amazon and release more supply upon the market as it’s demanded. But those efforts quickly get shut down and prosecuted so people end up hoarding TP in their basement for months and years to come.
To all this someone might reply, “well, why not just make a law / policy limiting the amount of TP purchases a person can make and set a fixed price.
Two problems with this:
- If prices are held constant regardless of high demand some people will just go all over town buying up TP day after day, and
- This policy prevents price from serving its most critical function as a signal to the market. If you simply set a law or policy limiting purchases on a good and set a price that’s too low then there is little incentive for the producer to make whatever investments or adjustments necessary to produce more and increase the supply on the market. Demand then goes unfulfilled.
So, a mandate “from above” doesn’t cure the problem. It only exacerbates it. We must let market forces do their job in balancing supply with demand. We must let economics play out so that resources are allocated where they are most needed and desired. It’s a far more effective approach especially in a large, complex economy like the United States. Sure, maybe it’d be different if the total economy only encompassed a few households, but that’s not reality.
The reason I’m spending time talking about TP is because the underlying lesson is so important. The TP shortage is simply a catalyst and real-time illustration of the lesson. The lesson is that prices are critical in coordinating activity in a complex economy that includes hundreds of millions of people with unlimited wants making millions of choices each day and performing millions of different tasks. A freely-functioning market is not only the best, most effective way to satisfy the greatest demand with minimal waste. It’s the only effective way.
Remember this lesson anytime a politician or bureaucrat has an idea for an economic policy. Anytime a bureaucrat wants to impact the price of a good or service, impact who pays for a good or service, or impact the price of money itself (e.g. interest rates) just know they are likely creating inefficiencies within the very complex system, and it will surely have unintended consequences that are not immediately visible.
There is a phenomenal, free book that brilliantly captures this concept called “Economics in One Lesson” by Henry Hazlitt. In the book, Mr. Hazlitt illustrates that the whole of economics can be boiled down to one lesson:
“The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.”
And therein lies the problem of politicians making economic policy. Whenever they do so they make a policy with one particular group in mind while ignoring the effects on other groups.
