Panic Doesn’t Suspend Economic Laws

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Posted: Mar 23, 2020 10:40 AM
Panic Doesn’t Suspend Economic Laws

Source: AP Photo/Bebeto Matthews

Considering recent panic buying, it’s worthwhile considering, again, the phenomenon of rising prices in times of scarcity. The best analogy I have seen is from Professor Antony Davies: “Trying to battle a shortage by prohibiting prices from rising is no different than trying to battle the virus by prohibiting thermometers from registering more than 98.6 degrees. Both ignore the disease in favor of regulating the tool that measures the disease.”

In times of scarcity, prices rise. That is not an ideology or an apology for greedy capitalists. It is a statement of fact, a reflection of logical necessity. It does make it more difficult for buyers, especially low-income people, and provides the truly compassionate with the opportunity to reach into their own pockets to help. The laws of supply and demand, however, as with all economic laws, arise from the composition of human logic and the strict limitations of the physical world. The law of demand, simply stated, is that, as the price of a particular good or service decreases, the quantity of the item demanded increases. The law of supply is the opposite, that, as the price decreases, the quantity supplied decreases. The demand curve slopes downward to the right, the supply curve slopes upward. That is not just an empirical reality in particular situations, but is, rather, an unavoidable conclusion.

Empirical economists sometimes claim that they have found exceptions to the laws of economics, and thus, they are situational and not really laws. The grave error of many or most such economists, as well as others, is that they assume that price includes only money exchanged, and this affects many of their ideas and theories. Price in economic discussions is usually shown as money units only for convenience, because it is easier to get one’s head around, but price is really what is called “opportunity cost.”

Opportunity cost, a well known and widely used term in economics, means everything that must be given up to pursue one particular course of action. That includes emotional, psychological, and any other type of cost, measurable or non-measurable. Resources, including time, are absolutely limited for every individual, so in order to do one thing, you must necessarily not do something else. You give up the opportunity to do one thing to be able to do the other. We run into that phenomenon every day, every minute of our lives.

If, instead of using dollars, which misses a very large part of the decision-making process, you use opportunity cost in all of its forms, supply and demand are totally adequate to explain every circumstance of human interaction. They must be. There are no exceptions. They result from human intelligence and the reaction to absolute physical limitations of reality.

Every individual values any item to be exchanged differently from every other person, depending on present circumstances, assumptions about the future, what other people think, and so on.  At any moment, some people will require a low price (opportunity cost) to induce them to exchange, while others are willing to exchange at even a high price (opportunity cost). It is a logical necessity that at lower prices, the number of people who value what they get more than what they have to give increases. The opposite occurs for supply. As price decreases, the number of people who value what they get more than what they give decreases. The market price is where the two meet. It is the market thermometer, the gauge of how well supply matches demand. 

Shortages, i.e. empty shelves, occur when markets are not allowed to adjust to scarcity. Restricting the gauge, the thermometer, does not cure the disease. It masks it and often extends it and makes it worse. Let’s quit doing that.