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September 14, 2017

Avoiding a Hurricane of Economic Fallacies

 

Every time there is a major disaster, such as a hurricane, it’s only a matter of hours before the economic fallacies come flying along with the wind.

The first fallacy to arrive is the “price gouging” fallacy. “Price gouging” is simply a pejorative term to describe the normal market response to shortages. It’s literally just supply and demand, but because even supposedly free-market states like Texas have laws against price gouging, and elected officials loudly trumpeting their aggressive enforcement of these laws, there is clearly a lot of misunderstanding.

Mostly, people misunderstand the idea of price itself—what exactly is a price anyway? A price is the most important concept in a market economy, because a price carries all of the immediate, real-time information necessary for consumers and suppliers to make good decisions.

In a functioning market economy, well in advance of a coming hurricane, prices on gas, water, plywood and other relevant commodities would start inching up. The price increases signal suppliers to start directing more resources to the area where prices are rising, in order to meet the demand, and these signals would start days before the arrival of a hurricane. In fact, it’s likely that during hurricane season prices will always inch up slightly. As consumers began stocking up, prices would continue to gradually rise, sending more intense signals that would drive more supply to the area. Entrepreneurs would seek to exploit the increased demand by loading up their pickups and bringing supplies into the high-demand area. This is how markets work to serve consumers and minimize harm in a disaster.

But when government steps in and arbitrarily restricts pricing, markets cease to work, and signals aren’t sent. In fact, contrary signals are sent—if you calibrate your prices to increased demand, you could get in trouble. And price gouging laws encourage even worse behavior, like store employees hoarding supplies, or customers buying up everything and selling at exorbitant prices on the black market. So price gouging laws actually harm the very people they are intended to help.

Soon after the price gouging fallacy comes the broken window fallacy, often stated as “despite the devastation of Hurricane X, there is actually a silver lining—the hurricane will actually be good for the economy!” The idea is that a broken window is actually a good thing, because it creates work for the window repairman. But the idea that disasters are “good” for the economy is a fallacy, or it would make sense to go through town and break all the windows! Yes, disasters result in increased economic activity, but this activity is necessary just to replace what was lost. A disaster is a net loss—it doesn’t result in additional economic growth. Absent a disaster, those resources would have gone into creating something additional, which would have been better for the economy.

Let’s try not to compound economic disasters with economic fallacies. Markets work better than governments, even in a disaster.


 

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