I was intending to write about other ideas first, but I think this is an important idea to try and get people to understand. I was at work the other day, strangely enough - yes, I have a job so my life now revolves around that - and of late much discussion has revolved around the recent earthquake in Christchurch. It is the second high impact earthquake in the last six months and was a lot more damaging than the first despite being weaker on the richter scale: 6.3 as opposed to 7.1. This is likely because the second earthquake occurred during a much busier time of day where people and vehicle density in the centre of town was much higher than in the first earthquake, Christchurch infrastructure and buildings were already in a weakened state due to the damage of the first earthquake and the second earthquake was shallower and in closer proximity to the city.

Nonetheless, that is just the background. The precise discussion I am concerned with is one that was had regarding prices as apparently some retailers have been raising prices to much higher levels than they previously had been. There was a level of disgust around this from some people and as I was pretty exhausted yesterday, I did not quite manage to formulate precisely why I had little problem with such behaviour, so I would like to explain here why such pricing is actually positive.

Basic economic theory suggests that an exogenous shock which decreases supply will lead to an increase in the price of the good being supplied. This is because the good being supplied is now more scarce and as such is more difficult to supply. In short, the cost of actually supplying the good has risen, so the price the supplier asks the consumer to pay will also be more. This price rise affects the quantity demanded. While demand for the good itself at any given price will not decrease as consumers preferences have not changed, the quantity demanded will decrease as the price has risen.

Basic economic theory, however, also suggests that an exogenous shock which increases demand will lead to an increase in the price paid for the good. This is because consumers now prefer the good more and as such are willing to pay more in order that they can have it. As such, demand will increase - the consumer is now willing to pay more for the same good - so price will rise.

The Christchurch earthquake was likely both an exogenous shock to supply and demand, decreasing supply and increasing demand. In terms of supply, there are added costs of supplying goods: an increased risk to life of actually staying around to supply the good, scarcity of actual goods, scarcity of inputs used in the supply, for example, available employees, money floats for giving change and so on. As such, supply has decreased and become more costly, so in theory prices should increase. In terms of demand, preferences are likely to have changed as there is now increased scarcity in the short-to-medium term which means the value of purchasing goods in the present while they are still available has risen. As such, demand has increased and there is greater willingness to pay, so in theory prices should rise.

The people I was discussing this with were disgusted with retailers who responded to the pricing mechanisms and increased their prices. They seemed to see it as a triumph of greed on the part of the retailers, but what they failed to consider was that retailers have increased costs and that there are negative ramifications to ignoring the pricing mechanism or attempting to implement alternatives. I understand that some believe that there are better alternatives to the pricing mechanism with regard to allocating resources efficiently and fairly, the most common in this kind of situation being supplier enforced quotas, so I will give some thought to the problems around them and follow that up with consideration of the ramifications.

Quotas have much less ability to counteract increased demand and have a large number of loopholes which the pricing mechanism does not. For example, there is nothing to stop a person going to multiple stores as early in the piece as possible and purchasing as much as a possible. There is also nothing to stop a person going in and out of the same store and doing the same, except for observation of suppliers which is likely to be unreliable particularly as many will be under a lot of stress. As well as this, there is nothing to stop multiple members of a family unit going in and all individually purchasing the same good that has a quota on it. As such, quotas are less effective than the pricing mechanism and they still disproportionately benefit the better off.

It is true that the pricing mechanism will disproportionately benefit the well off as well but under a quota system, because of the loopholes, those who are richer are still likely to be able to access a disproportionate amount of goods. At least with a pricing mechanism, there is something curbing the quantity they will demand. Furthermore, in the context of the Christchurch earthquake, those who are worse off can apply for Civil Defence payments to help with food, bedding and potentially other goods. The Civil Defence payment, however, goes through to a bank account overnight. Without a pricing mechanism curbing demand, the likelihood is that by the time the payment comes through, the needed goods will be far scarcer than they otherwise would.

When the pricing mechanism is ignored is when greed truly triumphs. Those consumers who get to the supplier first where the pricing mechanism has been ignored still have increased demand. As such, because prices have remained the same while their demand has increased, they purchase far more than they otherwise would. With scarcity, this means that supply is exhausted far faster than it otherwise would be and a potentially large number of those who need the goods more than those who got the goods earlier are left with far less than they need or even nothing. This is why retailers should respond to the pricing mechanism and this is why people need to change their attitudes about raising prices in times of scarcity.

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