Grocery shelves are looking better stocked these days, but not so long ago, items like toilet paper, cleaning supplies, flour, meat, puzzles and home gym equipment were barely available to anxious shoppers.
Why do these shortages exist?
When demand exceeds supply in a free market, the price will be bid up till the market clears. There should be disinfectant wipes available to those who are willing to pay the higher equilibrium price (I was!). How did we get away from equilibrium in some of these markets?
In most cases, both demand and supply moved. One does not have to look beyond the usual "shifters." Take toilet paper-- the poster child for shortages. Buyers expected future supply to be low, bought more and pushed up demand. In the textbook model, this would mean the price of toilet paper should start inching up, so that some buyers drop out and some sellers are able to supply more. This happens till we reach a point where the market clears-- there is no more excess demand. Demand was also primarily responsible for shortages in items like flour. Here the "shifter" is changes in tastes or preferences, specifically a heightened increase in baking.
In the case of meat, shortages were triggered by decreases in supply. Inputs into production namely, labor, became unavailable when workers fell sick, leading to closures of meat processing plants. When the supply shifted, prices would rise till buyers who were not willing to buy meat at the higher price tag dropped out, and suppliers who were receiving the higher price figured out a way to provide meat.
In all of these example, prices rose a bit, but shortages still remained. So what's up Demand & Supply? Why is the price too low?
The answer may lie in a principle that goes beyond the textbook: a high price is not "fair."
Nobel Prize winning economist Richard Thaler writes in the "The Law of Supply and Demand Isn't Fair":
Nobel Prize winning economist Richard Thaler writes in the "The Law of Supply and Demand Isn't Fair":
"Basically, it just isn’t socially acceptable to raise prices in an emergency.Most companies implicitly understand that abiding by the social norms of fairness should be part of their business model. In the current crisis, large retail chains have responded to the shortages of toilet paper not by raising the price but by limiting the amount each customer can buy."
That's nice and all, but why would firms care about fairness?
It's not about feeling "good"-- keeping prices low during a crisis can create longer-run profit.
"The large companies are playing a long game, and by behaving “fairly” they are hoping to retain customer loyalty after the emergency."
In the virtual world, things might play out differently. Price gouging is widespread. While retailers like Amazon and E-bay proactively bar third-party sellers selling at exorbitant prices, it seems to be a constant game of cat and mouse. Smaller entrepreneurs may have less incentive to maintain longer-term relationships. Thaler says:
"It is not that large retailers are intrinsically more ethical than the entrepreneurs; it is simply that they have different time horizons. The large companies are playing a long game, and by behaving “fairly” they are hoping to retain customer loyalty after the emergency. The entrepreneurs are just interested in a quick buck."
