Tuesday, July 03, 2007

Tell Me the Secret of the Hurricane

Tonight during my introductory economics class, I made mention of the story of Hurricane Fran after it swept through Raleigh, NC in 1996. In the aftermath of Fran, power was out, trees were down, and the heat was devastating.

In nearby Goldsboro four guys decided to rent a refrigerator truck, loaded it with ice and chain-sawed their way to the city center. Once there, they charged the locals $12 a bag--more than 10 times what it cost them to buy it. Anti-gouging laws took effect and the police arrested the men. (The trucks were impounded and turned off. The ice melted.)

We discussed how the pricing mechanism will sort out those who want ice for cold drinks and those who want it for their insulin or to ward off heat stroke. Prices do that. They are not perfect, but it is far better than a first-come-first-serve basis, where the fast or the healthy or the merely well placed get ice, leaving nothing for those that need it.

But the most powerful element of the pricing mechanism is that it creates the incentive to increase the supply and bid it down. At $12 a bag, others in Goldsboro have a reason to send more ice there and sell it for $11 or $10. Still, that's a high price and encourages yet more to come: $9, $8, $7. Lower, and lower. It's a strange paradox in economics: The only way to guarantee low prices is to allow sellers to charge high prices. But when you understand the role and power of incentives, it makes perfect sense.

For the full and deeper story, see this EconTalk.

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