Question

When the Law of Supply and Demand Isn’t Fair

By Richard Thaler

For an economist, one of the most jarring sights during the early weeks of the coronavirus crisis in the United States was the spectacle of bare shelves in sections of the supermarket.

There was no toilet paper or hand sanitizer. Pasta, flour and even yeast could be hard to find in the early weeks of social distancing, as many people decided to take up baking. Of far greater concern, hospitals could not buy enough of the masks, gowns and ventilators required to safely treat Covid-19 patients.

What happened to the laws of supply and demand? Why didn’t prices rise enough to clear the market, as economic models predict?

A paper that I wrote with my friends Daniel Kahneman, a psychologist, and Jack Knetsch, an economist, explored this problem. We found that the answer may be summed up with a single word, one you won’t find in the standard supply-and-demand models: fairness. Basically, it just isn’t socially acceptable to raise prices in an emergency.

We asked people questions about the actions of hypothetical firms. For example: “A hardware store has been selling snow shovels for $15. The morning after a blizzard the store raises the price of snow shovels to $20.”

Fully 82 percent of our respondents judged this to be unfair. The respondents were Canadians, known for their politeness, but the general findings have now been replicated and confirmed in studies around the world.

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. And Amazon and eBay prohibited what was viewed as price gouging on their sites.

We have seen similar behavior after hurricanes. As soon as a storm ends, there is typically enormous demand for goods like bottled water and plywood. Big retailers like Home Depot and Walmart anticipate this, sending trucks loaded with supplies to regions just outside the danger zone, ready to be deployed. Then, when it is safe, the stores provide water for free and sell the plywood at the list price or lower.

At the same time, some “entrepreneurs” are likely to behave differently. They see a disaster as an opportunity and so will fill up trucks with plywood near their homes, drive to the storm site and sell their goods for whatever price they can get.

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.

Fairness norms help explain the breakdown of supply chains of medical equipment in the coronavirus crisis. Hospitals normally use buying associations that make long-term deals with wholesalers to provide essential supplies. The wholesalers generally want to preserve these relationships and realize that now would not be a good time to raise prices. Often, they are contractually obligated to supply items at prices negotiated before a spike in demand.

One current example is the N95 face mask. At the onset of the pandemic, hospitals had long-term contracts to buy them for about 35 cents each, an executive at a New York hospital told me. When the need for the masks surged, these suppliers were not allowed to raise the price, even if inclined to do so.

But others along the supply chain could make big profits by diverting masks to anyone willing to pay top dollar. That left hospitals in a bind. As the coronavirus spread in New York, the executive’s hospital searched frantically for masks, eventually paying an overseas supplier $6 each, for hundreds of thousands of them, when the regular stock was desperately short.

When anyone tries to reap big profits in an emergency like this, it can look ugly. Consider the case of two brothers who began buying hand sanitizer, masks and other scarce commodities on March 1, the day of the first announcement of a Covid-19 death in the United States. After they sold some of their merchandise at big markups on Amazon and eBay, these outlets cut them off. Eventually, after considerable adverse publicity, the brothers decided to donate their supplies.

Notice that the brothers were making markets more “efficient,” by buying low and selling high. If instead of arbitraging coronavirus supplies they had sold shares of airline and hotel companies and bought shares of Netflix and Zoom, they would simply have been considered smart traders. But while smart trading may be fine for investments, it is not considered fair when it involves essential goods during a pandemic.

One can argue that this social norm is harmful in that it prevents markets from doing their magic. For example, Tyler Cowen, the George Mason University economist, has said he wishes it were OK to raise prices for coronavirus essentials.

“Higher prices discourage panic buying and increase the chance that the people who truly need particular goods and services have a greater chance of getting them,” he wrote.

But which people “truly need” N95 masks? What is the right allocation of masks among well-endowed research hospitals, poorly funded municipal facilities, nursing homes and food processing plants? Supply and demand would tell us that the masks should simply go to the buyer who was willing and able to pay the most for them. But fairness tells us this can’t be the only consideration.

As a practical matter for businesses, big and small, that want to keep operating for the long haul, it makes good sense to obey the law of fairness. If the next shortage is meat and a store owner realizes that there is only one package of pork chops left, it would be unwise sell it at auction to the highest bidder.

Richard H. Thaler is a professor of economics and behavioral science at the Booth School of Business at the University of Chicago. Follow him on Twitter: @R_Thaler

Economic Concepts:

scarcity implies competition

ethics

allocation mechanisms

trade-offs

COMMENT

Answer 1

Scarcity is the actual problem of economy, not only in pandemic but in the general situation of the economy too.

scarcity occurs because the resources are scarce in nature but the desires and to fulfill the desired with fuller utilisation of resources available with choosing best next alternative is what economics is known for.

when the resoyrces as mentioned or seen in the situation of oandemic resources few are scarce or few are utilised before the requirement due to less availability in the future, due to which people had to compete with one another for grabing the resources at first thus creating a strong competition.

basically, when same good is required by two or more at a same time creates competition.Therefore, we can that competition is an inescapable consequence of scarcity in the economy.

To overcome the problem , there is solution which may or maynot completely tackle the situation but work as neutrilizer of situation of scarcity , i.e. , rationing.

Rationing is the allocation of scarce resources in best possible way.and here it is the ethics which play role, as rationing done with fairness is the ethical way of dealing with the problem of scarce.

if there is scarcity of lets say, water in particular area, and instead of providing their water at the best possible lower rate if any enterpreneur sell water botles at double rate or more then it is against the ethics.

resource allocation mechanism : major question is of allocation of resources during this pandemic, as this was the huge question, which patient should be given priority, whi can use the health mechanism first, if medicine developed who will be among those getting the vaccine first , who should be considered and above this situation of optimal care and safety measures, man private organisations including private hospitals are there with the maximising the situation into opportunity and increase their revenues and profit.

so , in such situation best mechanism will be first in first served, either the situation of vaccine, food supply, medica equipments, etc.this is best principle to deal the situation without getting biased and practising the allocation of resources with ethics. with this they may get the equal claim but if the cases overflow then the biased practise is done, favourism to the close ones is done.

so to further tackle the situation ethically, there is another method to be followed in the flood of cases is to categorised the recovering ratio and work as per, same way if we talk about supplying the food or medical equipments now the other ethucal approach is to provide the facilty to the actual required one not to all, like food if shopkeeper have 10 kg of rice then instead of giving one to all give to all consumers lets say 4 each 2.5 kg this will let each of them have rice with the allocation .

then prioritising the one according to the requiremnet is the another approach, if one has cough and other have cold the they must be provided medicines as required respectively, not both the categories to both.

further to balance out the situation in the pandemic, tradeoff , best solution is to substitute the effect. tradeoff can be seen if the hands are taken togther. if wealthy ones are charged for the products in full and the poor one are given relaxation of the total dicount then trade will be balanced,

for eg if good is of $100 and discount due to pandemic is $40 then all had to pay $60

now lets assume rich are 10 people and poor are also 10

then instead of charging $60 to all, charge $100 from rich [ 10 people] and $60 to poor which will cost just $400 instead of $800 thus reliefing the traders , richers and poor , thus creating help from one to another.