Why Rising Prices Haven’t Stopped Shortages

Demand above supply is causing shortages, but Economics students learn that prices will rise to prevent shortages. Higher prices reduce quantity demanded and increase quantity supplied, until the two are equal. Why isn’t that happening today?

Government interference is one possible explanation, but it’s not a complete explanation. Scott Sumner posits fear of political heat from raising prices leading businesses to hold off on helping the market back into equilibrium. That may well be the case, but shortages can persist anyway.

Gun ammunition provides an example. The Sandy Hook school shooting in 2012 led some politicians to push for gun control, and many gun owners and would-be owners bought arms and ammunition in fear of a coming prohibition. As the surge in sales reduced inventory on store shelves, some buyers chose to buy some extra, just in case of a shortage. And a shortage soon developed.

In many markets, demand can increase faster than supply. People fearing future unavailability of a good act quickly. Manufacturers, though, have to add workers and train them , as well buy tools and machinery. This can take months or even years. (And with lots of gunpowder being used, safety training is pretty important.)

Retail stores chose on of two approaches to the ammunition production shortfall. Some small stores raised prices in line with textbook economics: They set prices at a level where their sales just matched the deliveries from manufacturers.  Prices were very high, but product was available. On internet gun forums, many people posted angry comments about price gouging, despite gun enthusiasts leaning more conservative than the average American.

The other approach was common to chains such as Walmart and Cabela’s. They kept prices unchanged (or only increased in line with costs), but sold out quickly. Although price-gouging laws may have been part of their thinking, mostly the companies wanted to maintain customer loyalty. Empty shelves made the store and the customer both sad, but essentially in the same boat. Raising prices, in contrast, would have risked customer anger.

Commodity markets—such as for soybeans or copper bars, trade in highly competitive environments with prices changing instantaneously. Shortages never exist. Customer loyalty is not important. But that’s just a small portion of all transactions in the economy.

Many business-to-business transactions also involve long-term relationships. Those pesky computer chips are manufactured by different companies and not absolutely identical. The software may have to be tweaked if a car company shifts from one brand of chip to another. And that software and chip had better work as intended, or people could die. So buyers want to stay with their supplier.

Such product “stickiness” occurs in many markets. An cabinet makes may have a preferred make of drawer slide, for which he owns the jigs and the know-how to quickly and accurate install them. A farmer may need all equipment compatible with a particular data system. Such relationships pervade the economy.

With such relationships, if the manufacturer jacks up the price to get demand equal to supply, then customers who cannot easily and quickly switch will feel taken advantage of. Instead, the buyer and seller make an implicit bargain. The seller won’t jack up prices when demand rises quickly and will allocate product to loyal customers to the extent it’s available. And the buyer does not switch to a low-cost provider when prices are falling. Both sides benefit from the long-term relationship. But the market does not clear immediately, unlike the blackboard illustrations we economists teach.

Actually, most Economics classes omit the issue of how long adjustment takes. Aside from markets with continuous trading for uniform commodities, price adjustment will always take time. There’s no doubt, however, that eventually rising prices will equilibrate supply and demand. But in the meantime, we may see shortages.

One important lesson that should be taught in Economics 101 is that elasticities of supply and demand can differ in the short-run from the long-run. Many manufactured products have low short-run elasticity of supply relative to income elasticities of demand, meaning that demand changes can occur faster than supply changes. Markets will clear eventually, but whether the immediate reaction is price increases or shortages depends on the institutional characteristics of the market, as well as government rules.