Re: Gas Shortage

Anonymous makes the following comment on my post on Gas Shortage:

Aren't price caps in place to protect commodities which have inelastic demand? You need gas to get to work. You'll buy gas at $7 per gallon if necessary.

Suppose merchants A, B and C set the price of gas to $7.00, when supply is severely constrained. When the supply returns to normal, merchant D will make enough money at $7.00 per gallon, that there is no motivation to lower it to $5.00 to gain the extra demand.

What am I missing?

You're missing several things:

1. Demand for gas *relatively* inelastic. It is not completely inelastic. My company recently encouraged people to work from home. That's an elasticity that allows for conservation of fuel. People also increase ridership in carpools and public transportation in order to decrease their demand for gas. Some people have started riding to work on scooters which get 100 mpg. Given sufficient time, people can be incredibly creative in their ability to conserve a scarce resource. High prices give them the signal to start thinking about the problem, and thus increase the elasticity of their demand.
   
   
2. Retail gas is extremely competitive. Competition will bring down high profit margins once the supply returns. Retailers who are charging a high profit margin will find themselves with a prisoner's dilemma: do I keep the price high and earn extra profits, or do I wait to lower them. If I wait, my competition may lower their prices first and I'll lose more than I'd lose if I lower my prices. So I'll lower my prices as soon as I can, so as to not lose customers.
   
   
3. Price caps actually have done a very poor job of protecting commodities with inelastic demand. When gas is gone, how much does it cost to get a gallon of gas? The answer is that no one has enough money to get it. It's gone. The price is infinite. Price caps intended prevent the price from going to $7/gal or $10/gal, actually raise the price to $infinity/gal. Price caps are an abject failure at what they're intended to do. They are intended to keep the price low, but they don't.
   
   
4. When there's a shortage, price caps don't allow for a smooth transition from high supply to shortage. You simply run out. People don't get a chance to figure out how they're going to work around the shortage. The supply just disappears one day. Whereas when the prices rise, people can stop other (less important) consumption in order to give themselves a little time to figure out how to conserve on the commodity that's in short supply. Price increases allows people to link things that have relatively inelastic demand with something that has higher elastic demand. This gives people time to think and devise a plan.
   
   What price caps do is create the illusion that there's no supply disruption until supply runs out. And then (rather suddenly) the price jumps up from $4/gal to infinity. And everyone's stuck trying to get a commodity that's gone with very little time to figure out an alternative.