Saturday, September 13, 2008

Gas, Hurricanes and Managing your Inventory

This is a marvelous post from Tennessee blogger Rich Hailey about reports of spiking gas prices in the path--and areas surrounding it--of Hurricane Ike. It's simple econ 101 but most people don't know it so they don't get it:

It's been more than a few hours, and shortages are already here.

So the price of a gallon of gas is skyrocketing, even at stations, like Pilot, that have enough gas to get through the interruption without going dry. So why are they raising their prices? Aren't they gouging?

Nope. If you've been out in Knoxville at all today, you've seen long lines of cars at gas stations. You've seen people filling up cars, trucks, motorcycles, lawnmowers and gas cans. They are in a panic mode, and they're buying more gas than usual. Even though Pilot has enough to get through the crisis at normal levels of sales, there's no way they can sustain sales at the rate they are going. So what do they do? They raise prices. By raising prices, they discourage people with brains from buying more gas than they need. They discourage people from driving more than they need to. In effect, they are encouraging conservation by using market forces rather than governmental coercion.

And it will work.

Consider the opposite case, where gas prices remain low, and everybody fills every container they can get their hands on with gas, and the stations run dry for the next three days. What happens when an ambulance needs to gas up? What happens when a fire truck needs fueling? What happens when you have an emergency and you need fuel but can't get any because everybody and his brother is hoarding it?

There are two ways to ration a short supply of a commodity. You allow the market to price it accordingly, and those who really need it will buy it, or you let the government come in and set the price. As a small government supporter, I favor the former. We're still dealing with the fallout of Nixon's wage and price controls from 40 years ago.

Anyway, that's what happened. Bulk storage facilities were acting to minimize the price of fuel and got caught short when the supply was interrupted. Barring major damage from Ike, supplies should be flowing again in a couple of days, and prices will resume their freefall.

The comments, for the most part underscore the basic point well. Something worth noting is this as it refers to 'motive':

I follow your explaination up to a point and the point is when you start ascribing altruistic motives to the gas companies - like helping us to conserve and saving enough gas for the ambulances and fire trucks. They just got the opportunity to sell their product substantially over cost and they pounced on it.

I look forward to the day that some technological advance is announced and the gas companies realize they can't sell all the product that they have on hand.

Gas station owners aren't acting altruistically, no. They are exhibiting the first and most profound of Adam Smith's observations: we directly benefit from the choices of others made in their own self-interests.

In this instance, the gas station owner has raised prices in anticipation of a supply shortage, in part at least, to maintain inventory. That act discourages what Hailey rightly describes as consumers engaging in "buying more gas than they need" and ultimately the more rational choice of conservation.

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