Monday, August 27, 2012

With hurricane Issac looming there are the inevitable cries of "Price Gouging!" with gasoline. Please read this to get some perspective before getting angry.

With hurricane Issac hitting Florida and the Gulf Coast, the inevitable rise in the price of gasoline and other commodities will make headlines and cries of "Price Gouging!" will arise.  Justified or not, at least consider the issue from an economic and business perspective.

Most businesses, on a daily basis, do not stock more inventory than they can sell. This is especially true if the good is perishable or expensive to keep in stock. In other words, they try to not have any unnecessary excess inventory if they can avoid it. 

If I am selling a good, say gasoline, that is both perishable and expensive to stock, I would like to time it so that the quantity of gasoline I supply in a 24 hour period (before the trucks come to re-supply me) equals the quantity of gasoline demanded by my customers. I have no or little excess gasoline in my tanks for the day.  This is just good business practice, agreed??

Let's say I have studied my inventory spreadsheets and determine on average I need 1,000 gallons of gas in my tanks (my quantity supplied) to meet my daily average quantity of gasoline demanded by my customers.

For me, quantity supplied (1,000 gal) = quantity demanded (1,000 gal) at, say, $3.00 per gallon. I am at a relatively steady equilibrium on a daily basis. So far so good.

Now there is a hurricane or some other natural disaster looming.  I notice not only are my customers for that day coming for gas, but so are some of the others who I know filled up the day before yesterday are coming in to "top off the tank". In addition, I also notice they have a gas can or two (or 5) with them.

Halfway through the day I check my gas inventory and see I am selling 20% more gas at that time relative to a normal day.  I project I would need 1,200 gallons at $3.00 a gallon to meet the needs of my customers.  At this rate my 1,000 gallon tank is going to be empty by late afternoon and my other, regular daily customers will not be able to buy ANY gas. I will be out!!  The anger will be palpable.

How do I avoid this?  My supplier can't get another truck to me in a timely manner because ALL the other gas stations in the area are experiencing the same thing I am (this more to this part of the story (the suppliers side) but I will leave it out for now).

Economic theory suggests if I raise the price for each gallon of gas then "at the margin" buyers will decrease their quantity demanded.  But the question becomes, how much do I have to raise the price of each gallon to make sure I have enough gasoline to sell to anyone who wants some for the rest of my business day?

My goal is to get each customer to purchase a little less gasoline than they otherwise would, even in the face of the natural disaster.  Maybe forgo filling one or two extra gas cans.  As each person purchases less then the cumulative effect will be such that I will have gas for everyone (or most everyone) who comes in to get some throughout the day.  That is admirable on my part, don't you think?

What increase in price would be enough to accomplish this? $.10 cents a gallon? $.20? $1.00?  More?

People are getting out of town. Gotta have gas!  Seems like it will take a significant increase in the price to incentivize them to think about each additional gallon of gas they are buying.  Again, if I can stop them through aggressive pricing from buying "too much" then there will be some for the next person--so on and so forth.

Here is my dilemma:  If I increase the price enough to sufficiently reduce quantity demanded to meet more needs/wants, people will yell "PRICE GOUGER!!" (But they are at least driving down the road).  On the other hand, if I run out of gas my customers are going to be mad AND not have any gasoline to get down the road. 

What am I to do? 

Note: Here is an article written by a REAL economist on this topic. Much more academic in nature than my analysis. Worth a read. 

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